Law in transitionAdvancing legal reform Autumn 1999
Corporate governanceFoundation for capital flows
Banks and bankruptcy in RussiaNew restructuring and insolvency laws
Patient pension capitalLegal considerations for portfolio investors
EBRD survey resultsMeasuring corporate governance
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Law in transitionAdvancing legal reform Autumn 1999
Contents
Corporate governance as a foundation of capital flows 1Charles Frank, First Vice President, EBRD
International financial standards and the transition economies 2Michael Taylor, Senior Economist, International Monetary Fund
Romania’s new Concession Law 9Michel Lequien, Senior Associate, Ashurst Morris Crisp
Restructuring and recovering debt from insolventRussian financial institutions 16Mira Davidovski, Partner, Salans Hertzfeld & Heilbronn
Focus on corporate governance
The role of the EBRD in promoting sound corporate governance 26Norbert Seiler, Deputy General Counsel, EBRD
Market perceptions of corporate governance – EBRD survey results 32Anita Ramasastry, Assistant Professor of Law, University of Washington,
Stefka Slavova, Doctoral Candidate, London School of Economics, and
David Bernstein, Chief Counsel, EBRD
Law and corporate governance in practice: BP Amoco p.l.c. 40Rodney L. Insall, Vice President Corporate Governance, BP Amoco p.l.c.
Corporate governance in western Europe: structures and comparisons 46Eddy Wymeersch, Professor, University of Ghent
Patient pension capital 51William Dale Crist, President of Board of Administration, and Kayla J. Gillan,
General Counsel, California Public Employees’ Retirement System
Polish pension reform and corporate governance issues 56Lukasz Konopielko, The Central and East European Economic Research Center
Aspects of corporate governance in Russia 61Denis Uvarov, Assistant, and Iain Fenn, Partner, Linklaters & Alliance
Legal transition developments 69
Legal transition eventsOECD conference on corporate governance in Russia 74Fianna Jesover, Project Manager,
Organization for Economic Co-operation and Development
General Counsel of the EBRD
Emmanuel Maurice
Co-Editors-in-Chief
Gerard Sanders, David Bernstein
Focus-Editors
Jonathan Bates, Hsianmin Chen
Contributing Editors
Joachim Menze, Junko Shiokawa,
Meni Styliadou, Alexei Zverev
Support
Mathew Chambers, Sandy Donaldson,
Anna Holowtschuk, Evgenia Ivanova,
Anthony Martin, Olivia Oddi, Jon Page,
Tabitha Sutcliffe, Jin Wakabayashi
The Office of the General Counsel gratefully
acknowledges the generous support of the
Government of Taipei China in funding the
production of this issue of Law in transition
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Charles Frank, First Vice President, European Bank for Reconstruction and Development
Corporate governance as afoundation of capital flowsSound corporate governance practices are a cornerstone
for attracting investment
As an international financial institution with a mandate to promote
private sector development, the EBRD has special reason to be
concerned with the issue of corporate governance. As one of the
largest lenders and investors in central and eastern Europe and the
Commonwealth of Independent States, the EBRD must satisfy itself
that enterprises and financial institutions in receipt of Bank financing
are properly organised under domestic legislation and that their
treatment of shareholders, customers, suppliers and other stakeholders
is transparent and complies with that legislation. Under the Agreement
Establishing the Bank, the EBRD’s equity investments are limited to
a minority position. The Bank is, therefore, particularly concerned with
how its investee companies treat their shareholders and whether minority
shareholders are able to have their legal rights enforced effectively.
These concerns led the EBRD to take an early, proactive approach
to the development and enforcement of sound principles of corporate
governance in all its countries of operations. In September 1997,
before the recent financial crises raised the profile of corporate
governance among international investors and lenders, the EBRD
published its own set of corporate governance guidelines, Sound
Business Standards and Corporate Practices. The objective of these
guidelines was to help companies and governments understand the
broader concerns of lenders and investors. The guidelines served
as a precursor to the recently published OECD Principles of Corporate
Governance. This issue of Law in transition is a continuation of the
Bank’s efforts to keep corporate governance high on the agenda
of our sponsors, clients and countries of operations.
The EBRD takes a two-pronged approach to promoting corporate
governance, as described in the article by the Bank’s Deputy General
Counsel, Norbert Seiler. Through integrity checks and the terms
and conditions of its investment operations, the Bank assesses and
influences the internal structure and operation of those enterprises
to which it intends to lend or invest. Sound corporate governance
and the integrity of an enterprise will continue to be an integral
component of the EBRD’s due diligence exercise before it makes
any financial commitment.
Through its Legal Transition Team, the EBRD fosters the appropriate
external environment – an extensive and effective legal and regulatory
framework – supporting sound corporate governance practices.
For example, the Bank is assisting the Czech Securities and Exchange
Commission and Russia’s Federal Commission for the Securities
Market to expand their securities laws and strengthen enforcement
powers. As noted in the article by Rodney Insall, BP Amoco’s Vice
President for Corporate Governance, this framework both defines
shareholder and creditor rights and creates and empowers the
institutions necessary for their effective enforcement. Several articles
in this issue note that the existence of a strong legal framework
supporting sound corporate governance practices is a key factor in the
decisions made by portfolio investors (such as the California pension
fund CalPERS) and foreign direct investors. The Bank also places
corporate governance practices on the agenda of its ongoing dialogue
with government and business leaders in the region, to impress upon
them the importance of good corporate governance practices to secure
EBRD and other financing.
The articles in the focus section of this issue of Law in transition
elaborate the importance of sound corporate governance principles
and practices in attracting the long-term capital flows necessary to
support economic growth and development.
This issue also addresses other important legal transition subjects.
Following on from the focus on financial market regulation in the
last issue, there is an article from Michael Taylor of the IMF on best
practice standards for banking and securities regulation and their
application to transition economies. This issue also contains one of
the first descriptions and assessments of the new legal and regulatory
structure crafted to deal with Russia’s banking crisis. With the second
of her articles on recovering debt in Russia, Mira Davidovski, a
partner at Salans Hertzfeld & Heilbronn, provides a guide to operating
under Russia’s new bank insolvency and bank restructuring laws.
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Michael Taylor, Senior Economist, Systemic Banking Issues Division,
Monetary and Exchange Affairs Department, International Monetary Fund†*
International financial standardsand the transition economiesIn recent years, best practice standards for banking and securities regulation
have been promulgated by the leading international groupings in these
fields. This article reviews the rationale behind these documents and considers
their application to the specific environment of the transition economies.
Within the last two years, the main international
organisations of banking and securities
regulators have separately promulgated
best practice standards for the guidance of
national regulatory bodies. The first set
of standards to be issued were the Basle
Committee on Banking Supervision’s Core
Principles for Effective Banking Supervision
(the “Core Principles”), which were issued
as a consultative document in May 1997
and adopted at the annual IMF/World Bank
meeting in Hong Kong the following
September. Following the adoption of the
Core Principles, the International Organization
of Securities Commissions (IOSCO) began
work on their own statement of the Objectives
and Principles of Securities Regulation (the
“Objectives and Principles”), which were
formally adopted by the organisation at its
23rd Annual Conference in September 1998.
Both the IOSCO Objectives and Principles and
the Basle Committee’s Core Principles have
a shared purpose in that they aim to provide
“a yardstick against which progress towards
effective regulation can be measured.”1
They are also similar in that both set out a
number of detailed principles which are
intended to be a statement of current best
practice in the design and operation of
regulatory regimes for their respective fields.
Another important feature of both documents
is that they are intended to be of general
application, and should in theory be of
greatest value to the developing and
transition economies that are currently
attempting to develop their regulatory systems.
Although the Basle Committee is a grouping
of G-10 central banks and bank regulators,
its Core Principles are not intended to be
restricted to the G-10 countries, and it took
the unusual step of co-opting a number
of emerging market regulators into its
deliberations. Indeed, the Core Principles’
adoption at the IMF/World Bank Annual
Meeting in 1997 and their subsequent
endorsement at the biannual international
meeting of bank supervisors in 1998
demonstrates that they are intended to apply
to both developing and developed markets.
Unlike the Basle Committee, IOSCO’s
membership has a genuinely international
scope, comprising 152 agencies from 88
countries (November 1997 figures). Its
Objectives and Principles are intended to be
the counterpart to the Core Principles in
providing a reference document of best
practice for securities regulators for the
emerging and developed markets. However,
the question remains whether these documents
will be able to perform the important function
for which they have been designed. In
particular, the extent to which it is possible
to transpose a set of principles evolved in the
developed markets into the very different
conditions of the developing and transition
economies has yet to be examined. This
article therefore falls naturally into two parts.
The first examines the basic rationale behind
the two documents, while the second reviews
a number of issues relating to their application
to the transition economies in particular.
The rationale for internationalfinancial standards
1 Banking regulation
Although the need for international standards
for banking and securities regulation might
be thought to derive from the same source,
in reality there are important differences in
the motivation for, and justification of, the
two documents. The Core Principles paper
explains its purpose in terms of the potential
for “weaknesses in the banking system of a
country … [to] threaten financial stability
both within that country and internationally.”2
In other words, the primary concern of
banking regulators is with financial stability.
Major banking sector problems can affect
financial stability both in a domestic context
and internationally, and the domestic costs
of recent banking sector bailouts have been
substantial. According to a survey conducted
by an IMF team, 133 out of 181 Fund
members suffered either “significant
problems” or a “crisis” in their banking
sectors between 1980 and spring 1996.
During this period 41 crises in 36 countries
were identified.3 The effects on the real
† This article was written while Michael Taylor was
Reader in Financial Regulation at the University
of Reading. He has since joined the staff of the
International Monetary Fund in its Monetary and
Exchange Affairs Department. The opinions
expressed in this article should not be attributed
to either the Monetary and Exchange Affairs
Department or the International Monetary Fund.
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economies and fiscal systems of those
countries were generally severe. The costs
of restructuring banking systems as the
result of major crises have varied between
4.5 per cent of GDP (in Norway and Sweden
in 1991) and 19.6 per cent of GDP (in Chile
in 1985). In the United States the costs of
resolving the Savings and Loan crisis of the
late 1980s are estimated to have amounted
to 5.1 per cent of GDP. Although both
developed and developing countries have
experienced banking crises, a disproportionate
share of them has occurred in the developing
markets, where their effects on macroeconomic
conditions have generally been more severe.
One factor shared by the otherwise very
different developing countries is that they are
engaged in the process of modernising and
liberalising their financial systems.4 This does
not in itself present an argument against
financial liberalisation, but it does show that
financial reform is likely to impose additional
stresses on banking systems. Financial
reform can thrust additional and unfamiliar
responsibilities on bank management and
regulators alike. The greater competition
which results from liberalisation can erode
franchise values and profitability built up in
cartelised markets, and can lead to excessive
risk-taking by management unfamiliar with
the trade-off between return and risk in the
new world of competitive markets. Financial
liberalisation can itself result in macroeconomic
volatility and asset-price fluctuations, which
can be damaging to banks’ balance sheets –
for example, as a result of over-investment
in particular sectors such as real estate or
commercial property.
To these general factors can be added
other more properly institutional factors
specific to the developing and transition
economies. These include excessive
government ownership of, and involvement
in, the banking sector, and poorly designed
official safety nets which encourage excessive
risk-taking by bank owners and managers
in the belief that they will be bailed out.
Connected lending in the form of loans to
bank owners and managers and their related
businesses results in a high concentration
of credit risk and a lack of objective credit
assessment. Regulatory forbearance –
especially in the form of allowing insolvent
institutions to remain open – can also result
from intense political pressure in these
environments, although in the long run its
main effect is to increase the costs of
resolving a banking crisis.
In this environment there is a clear need
to ensure that systems of banking regulation
and supervision are sufficiently robust to
withstand the additional strains imposed
by financial liberalisation. The concept
of the Basle Core Principles is to provide a
compendious guide to current best practice
in bank regulation, to enable banking
regulatory systems to be strengthened to
meet the additional challenges of financial
liberalisation. Thus, as part of their response
to the East Asian crisis, both the IMF and
World Bank have engaged in technical
assistance work to improve the quality of
banking regulation in the emerging markets
using the Core Principles as a guide. This
work involves designing regulatory regimes
in which regulators have sufficient powers
and resources (both human and financial)
to discharge their tasks adequately; it also
means devising incentive-compatible deposit
insurance schemes, and making provision
for the orderly exit of unsound banks.
Each of these features of a regulatory regime
is examined in the Core Principles.
However, improving the standards of bank
regulation in the emerging and transition
economies to help avoid a serious banking
crisis is not simply of domestic benefit to
those countries. A second important
motivation for encouraging adoption of
the Core Principles is the recognition that
supervisory weaknesses in one national
jurisdiction can result in problems
that can rapidly spill over into others.
This reflects the traditional concern
of bank regulators about the potential for
the collapse of a weakly capitalised bank
in one jurisdiction to trigger serious
problems in the international payments
system, illustrated most clearly by the
closure of Bankhaus Herstatt in 1974.
Payment systems risks are increasingly
internationalised, as are other linkages
between banks, especially in the interbank
market. One of the root causes of the East
Asian crisis was short-term lending by
developed world international commercial
banks to poorly-supervised local banks.
Once the East Asian crisis developed,
the extent of these exposures was sufficient
to impair the capital strength of several
developed world international commercial
banks. These inter-linkages mean that there
is a very strong incentive for bank regulators
to ensure that all countries responsible for
authorising and supervising banks adhere
to a set of common minimum standards, such
as those contained in the Core Principles.
2 Securities regulation
By contrast, securities regulators have not
traditionally shared the bank regulators’
concern with financial stability. This follows
from the nature of the risks that arise in the
securities business, and the balance sheet
structures of securities firms. The assets of
a securities house, unlike those of a bank,
mainly comprise marketable securities which
can be sold when the firm encounters funding
difficulties. In other words, there is not
the same mismatch between the liquidity
of assets and liabilities which characterises
1 Objectives and Principles, p.2. The Basle
Committee’s paper refers to “a basic reference
for supervisory and other public authorities in all
countries and internationally”.
2 Core Principles, p.1.
3 C.J. Lindgren, G. Garcia and M. Saal,
Bank Soundness and Macroeconomic Policy
(International Monetary Fund, 1996).
4 “Liberalisation” is used here to refer both to
the process of domestic deregulation and the
policy of opening domestic financial markets
to foreign competition.
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a bank’s balance sheet.5 This has important
implications, since it means that, in general,
securities firms can be allowed to fail with
little risk of loss to either investors or to
the wider financial system. Provided that
clearing and settlement systems are robust,
that adequate margin has been taken by the
clearing house, and that client assets have
been properly segregated from those of the
firm, then the failure of a market intermediary
is unlikely to have serious ramifications
for the financial security of the market, or
significant spill-over effects in other markets.
The securities markets’ lack of contagion
risk relative to the banking sector means
that problems there are less likely to be
either the source of significant dead-weight
losses to the economy as a whole or the
source of serious international instability.
While volatility in securities markets can
affect financial stability, it would need to be
intermediated through the banking system,
as happened in the United States following
the Great Crash of 1929. In this respect stock
market volatility is arguably little different
from volatility in other asset markets,
especially the real estate sector. This analysis
contrasts with that of the Emerging Markets
Committee of IOSCO, in its report on the
Causes, Effects and Implications of Financial
and Economic Turbulence in Emerging
Markets, which states that the events of 1997
“provided striking evidence of the power of
financial contagion in today’s environment”
and in particular of the potential for the
disruption of orderly conditions in securities
markets to occur on a cross-border basis.
However, for reasons already explained,
stock market volatility is not directly a cause
of systemic problems and for this reason
systemic stability should not be a key objective
of securities regulation. Securities regulators
can best help contain the potential systemic
impact of the markets they regulate by ensuring
their financial security. This includes, for
example, paying attention to settlement and
clearing systems, the capitalisation of market
intermediaries, and market default procedures.
Obviously, the reduction of systemic risk will
be one corollary of this activity, but it is not its
primary purpose. Indeed, the financial security
objective is as much an issue of investor
protection as it is of systemic protection.
These considerations imply that the financial
stability objective, which is the guiding
principle behind the Basle Core Principles,
need not form a major component of the
IOSCO Objectives and Principles. For this
reason, the inclusion in the Objectives and
Principles of the reduction of systemic risk as
one of the three core objectives of securities
regulation is misguided.
This is not to say that well developed
securities markets cannot make a significant
contribution to ensuring long-term financial
stability. In recent years the Bretton Woods
institutions have emphasised the importance
of developing bond and equity markets
as a way of reducing the financial fragility
of emerging economies.6 The development
of direct financing mechanisms in the form
of stock and bond markets can serve to
diversify risk within the financial system
and can reduce the dependence of these
economies on finance intermediated through
banking systems. In addition, the greater
use of bond and equity markets by emerging
economies can also serve to reduce financial
fragility in the developed world, by helping
shift the exposure to the emerging economies
from commercial banks to portfolio investors;
had more of the risk in East Asia been
borne by portfolio investors the contagion
effects of the crisis might have been less
pronounced. Lastly, the development of
financial markets in the emerging and
transition economies can also help to foster
financial stability by providing mechanisms
for risk transfer and hedging by banks.
The problem to which the absence of
hedging opportunities can give rise is also
illustrated by the East Asian example:
in this case banks compensated for their
inability to hedge their interest rate risk by
lending to their customers at floating rates.
The overall effect of this was simply to make
banks’ customers more vulnerable to the
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sharp rises in interest rates which followed
the authorities’ decision to allow their
currencies to float freely.
While each of these factors is an important
reason for seeking to encourage the long-term
development of securities markets, they do
not provide a justification comparable to that
behind the development of international
minimum standards for banking regulation:
the fear of contagion risk. Instead, as the
IOSCO Objectives and Principles paper itself
states, the main objectives of securities
regulators are less concerned with financial
stability than with ensuring:
■ the protection of investors, and
■ that markets are fair, efficient and
transparent.
The concept of investor protection as it
appears in the Objectives and Principles paper
is explained as follows: “The most important
means for ensuring investor protection is the
requirement of full disclosure of information
material to investors’ decisions. Investors are,
thereby, better able to protect their own
interests.”7 In other words, the essence of
securities regulation is to ensure that
investors are placed in a position to make a
fully informed judgement of the potential risk
and return characteristics of a security.8
The principle of “freedom with disclosure”
contrasts with the notion that it is in some
sense part of the regulatory task either to
substitute for the decisions of informed
investors (for example by the “pre-approval”
of securities issues) or to direct capital flows
into specific channels.9 Hence, IOSCO’s
investor protection principle implies a more
market-based approach than has been typical
of many jurisdictions, especially in the
transition economies.
The second objective supports the first in
that fair, efficient and transparent markets
are ones in which the process of price
discovery will operate on the basis of the
information available to all investors.
This objective concerns such matters as
the authorisation of exchanges, ensuring
a reliable price formation process, and the
prevention of improper trading practices
including market manipulation and insider
dealing. The Objectives and Principles paper
also states that regulation should promote
the efficiency of markets, although market
efficiency is not defined in the document.10
In practice, market efficiency should include
both a concern with the competitiveness of
a market (for example preventing anti-
competitive behaviour with regard to the
provision and pricing of broker/dealer
services) and a concern with the market’s
architecture as it affects the process of price
discovery (for example issues of liquidity,
thinness and variability).
The pursuit of these two objectives in
increasingly internationalised financial
markets necessitates greater cooperation
between securities regulators than hitherto.
The development of integrated capital
markets has had at least three major
implications for securities regulators, namely:
■ the geographical diversification of the
intermediaries whose activities they
regulate;
■ the increasing volume of cross-border
investment; and
■ the development of transnational markets,
which are more difficult to supervise.
The problems that integrated capital
markets can create for regulators are well
illustrated by the last of these implications.
As a result of companies seeking multiple
listings on different national exchanges,
it is now possible for market manipulation
or insider trading to involve transactions
on several different markets across several
jurisdictions. Perpetrators of these types
of market abuse are now able to act in other
countries by using telecommunications
networks or, increasingly, the Internet.
These developments have made it increasingly
difficult for a securities regulator in one
country to draw a clear boundary around
the “market” it is responsible for monitoring.
Hence, as the Objectives and Principles
paper notes, “in a global and integrated
environment regulators must be in a position
to assess the nature of cross-border conduct
if they are to ensure the existence of fair,
efficient and transparent markets.”11
In this environment, regulators from
different national jurisdictions are becoming
increasingly interdependent, and there
is a view that “there must be strong links
between regulators and a capacity to give
effect to those links. Regulators must also
have confidence in one another.”12 The
formulation of a “common set of guiding
principles and shared regulatory objectives”
is therefore partly a “confidence-building”
measure. In this context, “confidence”
primarily concerns the ability of different
national regulators to gather, share and keep
confidential information about market
conduct. Thus the need for international
5 This section is based on the discussion in
R.J. Herring and R.E. Litan, Financial Regulation
in the Global Economy (Brookings Institution,
Washington D.C., 1995), p.72.
6 See the speech by Michel Camdessus, Managing
Director IMF, Royal Institute for International
Affairs, London, 8 May 1998, available at the IMF
website: www.imf.org.
7 Objectives and Principles, p.6.
8 Compare Judge Louis D. Brandeis: “It is now
recognised in the simplest merchandising, that
there should be full disclosures. The archaic
doctrine of caveat emptor is vanishing. The law
has begun to require publicity in aid of fair
dealing. The Federal Pure Food Law does not
guarantee quality or prices; but it helps the buyer
to judge of quality by requiring disclosure of
ingredients. Among the most important facts to
be learned for determining the real value of a
security is the amount of water it contains.”
Other People’s Money (New York, 1914), p.103.
9 The pre-approval of securities is also sometimes
termed ‘merit regulation” and as such is
contrasted with disclosure regulation. See J.P.
Trachtman, “Perestroika in Bank Regulation:
Advantages of Securities Regulation for a Market
Economy” in J.J. Norton (ed.) Bank Regulation
and Supervision in the 1990s (Lloyd’s of London
Press, 1991), p.158.
10 Objectives and Principles, p.7.
11 Objectives and Principles, p.2.
12 Objectives and Principles, p.2.
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cooperation between securities regulators
is related largely to their ability to gather
and share information, and the Objectives
and Principles document has a different
focus to that of the Basle Core Principles.
Although the IOSCO paper recommends a
number of prudential standards that overlap
with those of the Basle Committee, its focus
is elsewhere. It is not primarily concerned
with the regulation of a specific set of
institutions, as are the Core Principles, but
with the regulation of markets and activities.
In this context the regulator’s capacity
for gathering and sharing information with
counterparts in other jurisdictions is the most
important international aspect of regulation.
In general, therefore, the difference between
the Objectives and Principles and the Basle
Committee’s Core Principles can be
summarised as follows: the Core Principles
are a response to a series of banking crises
which have disproportionately affected the
emerging markets and which have been the
cause of serious economic dislocation both
domestically and internationally. By contrast,
notwithstanding the perception that the East
Asian crisis exemplifies a form of “contagion”
risk in the securities markets, the IOSCO
document should be seen as a response to the
mounting difficulties encountered by regulators
in exercising their monitoring and enforcement
powers in increasingly internationalised
markets. The development of securities markets
in the emerging economies contributes only
indirectly to the goal of financial stability,
which is the Core Principles’ main focus.
Because finance in the transition economies
remains highly intermediated through banking
systems, the development of regulatory
systems that comply with the Basle Core
Principles should be their highest priority.
The IOSCO Objectives and Principles are less
clearly linked to fostering financial stability,
and are best seen as part of a longer-term
development strategy in which the growth
of securities markets is encouraged to relieve
some of the pressures on the banking system
and thereby reduce the potential fragility
of the system.
The application of internationalstandards in the transitioneconomies
It remains to be considered how useful
these two documents are likely to be in
fostering high regulatory standards in the
banking and securities industries of the
transition economies. The first point to
stress is that both documents present their
principles at quite a high level of generality.
IOSCO’s Principles are frequently qualified
by phrases like “in general” or “in some
jurisdictions” and hence do not represent
an unequivocal statement of best practice.
In this respect, the IOSCO Objectives
and Principles, while more detailed than
the Basle Core Principles, are also less
clearly a guide to international best
practice standards.
To a large extent, the comparative lack
of prescription in the IOSCO document
reflects the organisation’s complex decision-
making procedures, with their need
to obtain the agreement not only of the
16-member Technical Committee (on which
the main developed markets are represented)
but also of the 63-member Emerging
Markets Committee, which includes a
number of transition countries among its
membership. Because the Basle Committee
is a much smaller, more cohesive group
of G-10 officials, it has been able to be more
prescriptive than has IOSCO.
However, even the Basle Core Principles
cannot be translated into a set of specific
policy recommendations without the
intermediation of more detailed guidance
and interpretation. A group of officials
from the Basle Committee and international
financial institutions is currently attempting
to develop such guidance, but the fact
that this step has proved necessary shows
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the difficulty in actually applying the
Core Principles to specific situations.
The current chairman of the Basle Committee,
Bill McDonough, has compared the Core
Principles to the United States Constitution,
a document which has been repeatedly
interpreted and reinterpreted over the
centuries.13 Correspondingly, he argues,
the Core Principles can only be applied
to the circumstances of individual countries
through the interpretative efforts of numerous
technical experts and advisers.
Nonetheless, the Basle Core Principles
have been criticised by some commentators,
including some emerging market regulators,
for failing to pay sufficient heed to the very
different conditions which prevail in the
emerging markets compared with the
developed markets. These deficiencies have
been discussed in particular by Morris
Goldstein.14 In particular, he has pointed out
that the 8 per cent minimum capital ratio
prescribed in the Basle Capital Accord
(to which the Core Principles refer) is too
low in countries that experience volatile
economic conditions. Moreover, the Basle
Committee has yet to produce guidance on
the recognition of non-performing loans, even
though a failure to value assets correctly
and to write down losses against capital make
a nonsense of any capital ratio regulators
might prescribe.
These criticisms can be addressed through
the preparation of detailed guidance for
the application of the Core Principles to the
emerging markets and transition economies.
More significant, perhaps, is that the Core
Principles presuppose an “infrastructure”
of regulation which usually goes unremarked
in the developed economies but which is
often lacking from the emerging markets and
transition economies. Although the Basle
Committee co-opted a number of emerging
market regulators into its deliberations in
formulating the Core Principles, it nonetheless
remained a predominately developed-world
grouping. This meant that it has tended to
make assumptions which reflect the conditions
in the developed markets, especially
concerning the availability of adequate and
accurate accounting information and the
existence of a legal system through which
regulators can enforce their decisions.
Regulation of banks and securities markets
is, in a sense, an “overlay” to a set of laws,
practices, skills and expertise which are the
prerequisites for effective regulation. Without
these preconditions in place, the regulatory
function is unlikely to be discharged either
efficiently or effectively. To an extent, of
course, this is simply another way of stating
the well-worn concept of sequencing: for
example, to develop an effective stock
market, it is necessary to first put in place
contract law and commercial law generally,
followed by laws on securities, the stock
exchange, negotiable instruments, and a law
governing institutional investors. Prior to all
these laws it may also be necessary to enact
a constitution, setting out the legislative
procedures and guaranteeing certain basic
private rights. Moreover, the drafting of laws
is only a preliminary to their implementation
and enforcement, for which training for
lawyers and judges is also required.
Only when something resembling these
prerequisites has been put in place does
a law on the regulation of stock exchange
transactions and intermediaries begin to
serve any real purpose.
The IOSCO Objectives and Principles contain
more explicit recognition than the Basle Core
Principles of the necessity of this infrastructure
of regulation. This is a reflection of the fact
that IOSCO’s decision-making processes have
forced the securities regulators to take account
of the specific conditions of the emerging
markets more explicitly than the Basle
Committee. Thus Annex 3 of the IOSCO
Objectives and Principles details a series of
elements of an appropriate legal framework
for an effective securities regulatory regime.
This includes company law, covering such
matters as company formation, the duties
of directors and officers, and the regulation
of take-over bids. It also includes a body of
commercial or contract law relating to private
rights of contract, property rights and rules
governing the transfer of those rights. Also
important are insolvency laws governing
the rights of security holders on winding up
and the rights of clients in the event of the
insolvency of an intermediary, and a law to
prevent anti-competitive practices.
In addition, the IOSCO document also
stresses the importance of an effective dispute
resolution system, including a fair and
efficient judicial system. A well-functioning
judicial system matters from the point of view
of regulatory enforcement actions. Without
a fair and efficient court system through
which to enforce regulatory decisions,
regulation will either be ineffective or will
lack legitimacy since it will come to be seen
merely as an arbitrary exercise of power.
Effective regulation importantly depends
on the clarity and consistency of regulatory
decision-making, and this is best guaranteed
by providing for the courts to review
regulatory decisions and for those affected
by them to have the option of appeal to an
independent and disinterested arbitrator.
This attention to the infrastructure of
regulation is a distinctive feature of the
IOSCO Objectives and Principles, and is
implicit recognition that effective regulation
cannot be divorced from the existence of an
effective legal system. Just as important
for both banking and securities regulation is
the existence of an accounting infrastructure
in parallel to the legal infrastructure, and
the enactment of an efficient bankruptcy
code. Accounting principles matter to
securities regulators since, as discussed
earlier, the disclosure of information is central
to their objectives. The existence of a set of
accounting principles is a precondition for
13 W. McDonough, “Interview”, The Financial
Regulator, Vol.3 No.3, p.32.
14 M. Goldstein, “Towards an International Banking
Standard”, The Financial Regulator, Vol.2 No.2.
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the disclosed information to be meaningful.
Similarly, the existence of an accounting
infrastructure is of vital importance to bank
regulation. Without a realistic valuation of
the assets and liabilities of a bank, a bank
regulator is in no position to judge whether
or not it is financially sound; the calculation
of a solvency ratio, for example, depends
on the assumption that the assets have been
correctly recognised and fairly valued.
One of the recurring problems in the East
Asian countries, and a major contributory
factor to banking system weakness, was that
bank assets had not been properly valued.
Non-performing loans were not recognised
as such, and even when they were write-
downs in their book value did not occur.
A functioning accountancy system also
matters to banking sector soundness in a
more fundamental way. An accountancy
system does not simply allow bank regulators
to assess the financial soundness of a bank;
it also enables the bank to assess the financial
soundness of its customers. In other words,
an accounting system is a precondition for
the existence of a “credit culture” in which
banks make their credit allocation decisions
on the basis of an objective assessment of
the cash flow prospects of the putative
borrower. In the absence of this credit
culture the decision to allocate credit will
be made according to other criteria: either
personal relationships or on the assumed
value of the collateral. Both of these types
of lending carry their risks. Although J.P.
Morgan famously declared that the first rule
of banking was “character”, personal
relationships do not provide a sound basis
of banking practice. Similarly, lending
secured on collateral can prove to be unsafe,
especially when the collateral is real estate
valued at the height of a speculative
property boom.
A further essential precondition for an
effective system of regulation is the existence
of a functioning bankruptcy code. As with
an accounting code, the existence of a
bankruptcy code matters both from the point
of view of the regulators and also from the
point of view of the development of a credit
culture. Bankruptcy and insolvency laws
confer rights on the security holders on
winding up. Too often transition economies
do not have a bankruptcy law at all or, where
such a law does exist, they often make it
very difficult and time-consuming for bankers
to recover the collateral behind delinquent
loans. This makes the efforts to reschedule
private debt more disorderly than otherwise
would be the case and adds significantly
to banks’ credit losses. Just as important is
the existence of legally enforceable netting
arrangements, which will permit banks to
offset liabilities against assets as they relate
to the same customer. These arrangements
are essential if the banking system is to
develop an effective credit culture and hence
the financial strength which follows from
this culture.
Similarly, from the point of view of the
regulators, it is vital that they should be in
a position to petition for the winding up of
unsound or insolvent financial institutions.
The existence of a bankruptcy code is
clearly an essential precondition for this.
Regulators will also be more inclined to
take this action if they believe that the
creditors of the institution will be able to
enforce their own rights at law. If ordinary
creditors are left with unenforceable claims
against an insolvent bank, the temptation
for regulators to exercise forbearance, to
delay action to avoid the consequent public
clamour, will be much greater. Hence, an
effective bankruptcy code also matters
from the point of view of encouraging
enforcement actions by the regulators.
Conclusion
Properly functioning legal and accounting
systems are essential preconditions for
effective regulation, and to this extent both
the IOSCO Objectives and Principles and
the Basle Committee’s Core Principles
cannot be divorced from the environment in
which they are implemented. McDonough’s
analogy with the United States Constitution
is highly pertinent, not least in drawing
attention to the fact that the Founding
Fathers shared many unspoken ideas and
concepts in common. They were able to
draw on a shared political culture, common
law tradition and political discourse, which
as colonists they had inherited from the
home country. Without this shared basis of
political agreement, it is doubtful that the
US constitution would ever have proved to
be as successful and long-lasting as it has
turned out to be. The unspoken foundations
of a constitution are as important as those
that are explicitly articulated.
The importance of these factors can be seen
in the various abortive attempts during the
late nineteenth and early twentieth centuries
to import constitutions modelled on that of the
United States into the newly decolonised
countries of Latin America. Without the
necessary infrastructure of shared principles,
beliefs and assumptions, these constitutions
rapidly became a dead letter. The same point
applies to the introduction of a regulatory
constitution to the transition economies at the
end of the twentieth century. Implementing
effective regulatory regimes will require more
than the enactment of a few laws and the
organisation of a few training programmes.
But how much more will be the real challenge
for implementing international financial
standards in the transition economies.
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* Michael Taylor
Senior Economist
Systemic Banking Issues Division
Monetary and Exchange Affairs Department
International Monetary Fund
700 19th St NW
Washington, DC 20431
USA
Tel: +1 202 623 6388
Fax: +1 202 623 8964
E-mail: [email protected]
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 8
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Michel Lequien, Senior Associate, Ashurst Morris Crisp*
Romania’s new Concession Law
Romania has a long-standing tradition
of concession. The possibility for the
private sector to operate public property
or public services was already recognised
before the beginning of the century and
progressively organised in Romania2 until
the institution of a socialist constitution
on 13 April 1948 and the subsequent
passing of a series of nationalisation laws,
which have progressively prohibited
any involvement of private operators in
the economy. It is only since the 1989
“December Revolution” and the
liberalisation of the economy that the
concession has been revived in Romania.
Constitutional and legalframework
Article 135 of the 1991 Constitution
provides that: (i) the assets which
are public property cannot be alienated
to private entities; and (ii) public property
assets may be “administered” (administrate)
by self-managed public companies
(such as Regii Autonome) or public
institutions, or may be leased or granted
in concession to private persons. It is
generally considered that public property
cannot be operated in a form other than
as listed in Article 135.
Until the passing of the Concession Law,
the only general rules providing for
procedures for the granting of concessions
and determining the contents of concession
agreements were Articles 25 to 29 of Law
No. 15/1990 “on the Reorganisation of
State Economic Units into Regii Autonome
and Commercial Companies”, and
Government Decision No. 1228/1990
“on the Approval of the Methodology of the
Concession and Lease”. These regulations
were, to a large extent, inspired by the
general regulations provided by the Law
of 28 March 1929 “on Mining”. They have
now been abrogated by the Concession Law.
On 29 January 1999, a new law on concessions came into force in
Romania (the “Concession Law”). The Concession Law1 unifies and
clarifies the legal regime applicable to concessions and constitutes
an important step towards the establishment of a regulatory framework
better adapted to the development of concession projects in Romania.
This article summarises the main provisions of the Concession Law
and examines certain issues related to their practical application.
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Emergency Government Ordinance No. 30/
1997 “on the Reorganisation of Regii
Autonome” (as approved and amended by
Law No. 207/1997) provides that the
commercial companies resulting from the
reorganisation of Regii Autonome will
automatically be granted a concession over
the public property under their administration
at the time of their reorganisation.
Concerning local concessions, Law No.
69/1991 “on Local Public Administration”
provides that local governments are entitled
to grant concessions in relation to their assets
or local public services. However, Law No.
69/1991 does not specifically define local
public services and does not determine the
legal regime applicable to concessions
granted by local authorities, so that such
regime was unclear prior to the adoption
of the Concession Law. Doubts existed in
particular as to whether Law No. 15/1990
and Government Decision No. 1228/1990
(which had been adopted prior to Law
No. 69/1991 and did not specifically refer
to concessions granted by local authorities)
effectively applied to local concessions.
Finally, in addition to these general regulations
governing the concession in Romania, and
which have now been completed by the
Concession Law, a sectoral regulation of the
concession was adopted specifically for the
development of motorway and railway
concession projects (Ordinance No. 30/95
“on the Concession Regime for Construction
and Exploitation of Land Communication
Lines, Highways and Railways”, approved by
Law No. 136/96). In our opinion, Ordinance
No. 30/95, which the Concession Law does
not expressly abrogate, remains in force after
the entry into effect of the Concession Law.
The Concession Law
I. Definition and general principlesgoverning the concession
Definition of the concession
The Concession Law unifies and clarifies the
legal regime applicable to concessions by
providing a general definition of the
concession and setting forth general rules
applicable to national as well as local
concessions. Pursuant to the Concession Law,
a concession is established
“(...) by a contract pursuant to which a person,
designated as the ‘conceding authority’ grants
to another person, designated as the
‘concessionaire’, for a determined time period
that may not exceed 49 years, the right and
the obligation to operate a public property, a
public activity or a public service at its own
risk and under its own responsibility and
against the payment of a concession fee.”
(Article 1.2)
Object of the concession
In accordance with the Concession Law,
assets which can be granted in concession
are public and private property assets
belonging to the State, counties (judete), cities
(orase) or villages (comune). The public
activities and services that can be granted
in concession comprise public activities
and services of “national interest” or of
“local interest”.
The Concession Law provides a list of such
public property, public activities or public
services which can be granted in concession.
It does not, however, provide for a specific
definition of, and distinction between, the
notions of “public activity” or “public
service”. The list includes property and
activities that are classically the subject of
concessions in other legal systems, ranging
from public transportation, motorways,
bridges and road tunnels and waste manag-
ement to frequencies and telecommunication
networks, drinking-water networks or
beaches, docks and custom-free zones.
The list provided by the Concession Law is
only indicative, and generally, except where
prohibited by a special organic law,3 all
public property, activities or services can be
granted in concession (Article 2.2, para. t).
An important limitation to the possibility for
the government or local authorities to grant
concessions has been introduced by Article 2.3
of the Concession Law, which states that
public property, activities or services cannot
be granted in concession if there does not
exist a regulatory authority “whose opinion
is binding concerning the prices and tariffs
applied by the concessionaires”. The provision
was introduced by the Senate at the end of
the legislative process and is probably
meant to refer to the sectoral authorities
that are intended to be established to
regulate independently various fields
of the Romanian economy.
In the absence of such authorities as of to
date,4 the requirement set out in Article 2.3
of the Concession Law could hamper or at
least delay the development of concession
projects in Romania. In any event, the
requirement does not appear appropriate
with respect to public property concessions
(for example, mining concessions) that do not
imply the operation of a public service and a
relationship with private users of such service.
With respect to local public service
concessions, the requirement could further be
seen as contradictory with the trend towards
an effective decentralisation at the level of
local authorities of the establishment of
prices and tariffs of local public services,
which appeared to be promoted by the draft
Law “on Local Public Services” submitted to
Parliament on 15 September 1998.5
National and local interest concessions
The Concession Law does not provide a
definition of such activities or services that
are of local or national “interest”, and a
specific definition thereof may not be found
in other Romanian legislation. Law No. 213/
1998 “on Public Property and the Legal
Regime Applicable Thereto”6, however, sets
out certain principles for the allocation of
public property assets among national and
local authorities and lists,7 from which it is
possible to derive, with respect to certain
services, an allocation of such services
among national and local interest services.
It is expected that the Law “on Local Public
Services”, when adopted, will further improve
the definition of those services that shall be
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considered of “local interest” and clarify the
allocation of responsibilities for such services
among local authorities.
Conceding authority
Article 5 of the Concession Law determines
which authorities and institutions may be
deemed conceding authorities within the
meaning of the Concession Law, as follows:
■ the ministries and the other specialised
organs of the central public administration
are conceding authorities with respect to
the assets belonging to the public or private
property of the State, or public activities
or services of national interest;
■ the county councils, local councils or
public institutions of local interest are the
conceding authorities with respect to the
assets belonging to the public or private
property of the counties, the cities or the
villages, respectively, or public activities
or services of local interest.
As it appears from the complex and somewhat
imprecise language of the Concession Law,
it is necessary to rely on further clarification
of the respective responsibilities of the relevant
public authorities in respect of public property
assets and public services in other laws
(in particular, the Law “on Public Property”
and the future Law “on Local Public Services”)
to identify with certainty in all circumstances
the appropriate conceding authority.
Duration of the concession
Concerning the duration of a concession,
the Concession Law brings a significant
improvement to earlier concession legislation,
which provided that concessions could not be
granted for a duration exceeding 20 years8
and did not allow for any extension thereof.
The maximum duration of a concession is
now 49 years (Article 1.2).
Article 30 of the Concession Law sets forth
the general principle pursuant to which the
duration of a concession shall be established
based on the depreciation period applicable
in respect of the concessionaire’s investments
in public property for the development of the
public activity or service conceded to it.9
The duration of the concession shall be set out
in the concession agreement. Such duration
is subject, however, to the possibility for the
parties to a concession to extend the term of
the concession by mutual agreement for a
period of up to half of the original duration
thereof.10 Except for the principle requirement
that the duration of a concession must be
established based on the depreciation period
of the assets resulting from the concessionaire’s
investment, the Concession Law does not set
any specific criteria limiting the parties’ right
to agree on an extension.
Concession fee
The payment of a concession fee (redeventa)
by the concessionaire appears as a constitutive
element of the concession. The amount and
the terms of payment of the concession fee are
determined by the relevant ministry or local
authority, including cases where the concession
is granted by a “specialised organ of the central
public administration” or “a public institution
of local interest”. The amount and other terms
and conditions applicable to the concession
fee shall be provided in the terms of reference
(caiet de sarcini) issued for the attribution of
the concession (see section II hereafter).
While the Concession Law grants a greater
freedom to the conceding authority in the
determination of the amount and other terms
and conditions of the concession fee than in
earlier legislation,11 it remains strict in its
requirement that a concession fee be stipulated
as part of any concession. This may not be
appropriate for all types of concession.
The requirement could be alleviated, however,
by mechanisms pursuant to which the
concession fee (or a part thereof) would be
returned to the concessionaire by the conceding
authority in the form of investment subsidies
for the purposes of financing specific
investments in the public assets operated by
the concessionaire (thereby limiting the impact
of the concession fee on tariffs). However,
the prohibition under Romanian law of any
subsidisation of commercial companies,
irrespective of whether these commercial
companies are operating a public service or
not and irrespective of whether the subsidy
1 Law No. 219/1998 “on the Regime of
Concessions”, adopted on 28 October 1998 at a
plenary session of the Chamber of Deputies and
the Senate and promulgated on 24 November
1998 by the President of the Republic. The
“methodological norms” for the implementation of
the Concession Law were adopted by Government
Decision No. 216 on 25 March 1999.
2 In particular, the Law of 16 March 1929 “for the
Commercial Organisation and Administration of
Public Enterprises and Assets”; the Law of 28
March 1929 “on Mining” and the Law of 4 July
1924 “on Energy”. A body of case law in respect
of public property concessions as well as public
services concessions was also developed in
Romania by the courts until 1948.
3 In accordance with Article 72 of the Constitution,
an organic law is a law that may only be adopted
by the vote of a qualified majority of the Deputies
at the Chamber of Deputies and of the Senators
at the Senate, respectively.
4 As of 1 July 1999, to our knowledge, only the
National Agency for Mineral Resources and the
National Energy Agency had been established,
and the Romanian Telecommunication Agency
was in the course of being established.
5 The draft Law “on Local Public Services” is
expected to define local public services and
specify how they will be organised. It is expected
to specify what form the concessions are to take.
It must be noted, however, that the discussion of
the draft Law “on Public Services” has since been
regularly postponed apparently, among other
reasons, due to conflicting views on the extent
to which decentralisation of the state’s functions
and regulatory powers is to be pursued
in Romania.
6 Law No. 213/1998 came into force on
22 January 1999.
7 For example, Law No. 213/1998 provides that
electricity distribution networks belong to the
public property of the state and that water,
heating and gas distribution networks belong to
the public property of municipe, towns and
villages (respectively, para. 14 of Part I and
para. 4 of Part III of the Annex to the Law on
Public Property).
8 Article 27 of Law No. 15/1990 “relating to the
Reorganisation of State Economical Units into
Regii Autonome and Commercial Companies”.
9 Romanian depreciation rules are contained in Law
No. 15/1994 “on Depreciation”.
10 It is generally agreed among practitioners that
the limitation of the duration of concessions to
49 years provided by the Concession Law does
not affect the possibility for the parties to agree
to an extension of the original concession beyond
such a duration, so that, for example, a 49-year
concession could be extended by up to 24.5 years.
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is for investments in public property or for
covering operating expenses (which would
be difficult to justify), currently forbids the
implementation of any such contribution
mechanism by conceding authorities.
II. The granting of a concession
The Concession Law provides in its Chapters
II and III for general rules governing the
procedures relating to the inception of
concession projects and the granting of
national and local concessions, and ensuring
the transparency of the bidding process
(Articles 6-27).
It is beyond the scope of this article to
describe in detail the procedures set out in
the Concession Law. The Concession Law
appears largely to over-regulate such
procedures, which would have normally been
left for development in the regulations for
the implementation of the Law established
by the government (called “methodological
norms” in Romania).12 We will restrict,
therefore, our review to a limited number of
key provisions of the Concession Law.
Inception of a concession project
A concession project may be initiated either
by a “potential” conceding authority, or by
any “investor” (i.e., a concession operator)
interested in the concession (Article 6).
Prior to initiating a procedure for the granting
of a concession, the conceding authority
shall prepare a feasibility study (studiu de
oportunitate) analysing, among others:
(i) the economic, financial, social and
environmental reasons justifying the
granting of a concession;
(ii) the amount of investments required for
the modernisation or upgrading of the
relevant public property or public
activity or service;
(iii) the minimum level of the concession fee;
(iv) the procedure to be followed for the
granting of the concession; and
(v) the estimated duration of the proposed
concession.
If the concession project is initiated at the
request of an interested operator, the relevant
authority must prepare the feasibility study
within 30 days of the request of the operator
(or such other period of time as agreed
between the authority and the operator).
Procedures for the granting of a concession
In accordance with Article 10 of the
Concession Law, the concession is granted
pursuant to a tender (licitatie) or as a result
of direct negotiations (negociere directa).
Tender procedures
A tender for the granting of a concession may
be open or closed. An open tender is a tender
in which any Romanian or foreign private
person (physical or corporate) may participate.
The call for an open tender is published in
the official gazette and in national and local
newspapers. There is no obligation in the
Concession Law for the public authority
that is launching the tender to make any
publication in the international press.
A closed tender is a tender in which only
a limited number of pre-qualified Romanian
or foreign tenderers may participate.
The pre-qualification of tenderers in a closed
tender shall be based on criteria established
by the conceding authority in advance.
As in the case of an open tender, the
invitation setting forth the criteria to qualify
for participation in the closed tender must
be published in the official gazette and in
national and local newspapers.
Terms of reference of the concession
The tender procedure, whether open or
closed, shall be based on terms of reference
prepared by the conceding authority.
In accordance with Article 12, such terms
of reference must set out:13
■ the terms and conditions applicable
to the operation of the concession;
■ the investments to be carried out by
the concessionaire;
■ the “financial and insurance clause”
of the concession;
■ the “legal regime of the assets that
will be used by the concessionaire”
(in particular the regime applicable to
the relevant public domain assets);
■ environmental protection obligations.
The matters listed above constitute
mandatory items which must be determined
by the conceding authority at the outset of
the tender procedure. The methodological
norms for the implementation of the
Concession Law, however, do not expand
on the precise scope and contents thereof,
leaving unclear what exactly shall be
understood under terms like “financial
and insurance clauses” of the concession
(probably the tenders propose tariff structure
for the concession and amounts for the
insurance policies relating to the public
property assets), and generally, what is the
level of detail required in the determination
of such matters in the terms of reference
for the concession.
Direct negotiations
It is only in limited circumstances that a
conceding authority may resort to direct
negotiations with a potential concessionaire,
since a concession may be granted through
direct negotiations only in those cases where
a tender procedure has not allowed the
selection of a concessionaire (Article 26).14
In such a case, the terms and conditions
of the concession granted through direct
negotiations may not be less favourable than
those of the best offer received in the
unsuccessful tender procedure (Article 19(4)).
This latter requirement, while attempting
to set a minimum protective standard for
conceding authorities in their “direct
negotiations” with operators may, however,
be impractical. In particular, given the multi-
criteria tender evaluation method promoted
by the Concession Law,15 it is likely that
the determination whether the terms and
conditions of a concession granted following
direct negotiations are more or less favourable
than those of the best (but rejected) tender
in a failed tender procedure will be most
difficult and open to criticism and claims.
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III. The concession contract
The Concession Law sets out in its Chapter
IV a certain number of rules governing the
contents of the concession contract between
a concessionaire and a conceding authority.16
Mandatory and contractual provisions
The Concession Law makes a distinction
between the mandatory provisions of the
concession contract (also designated in the
Concession Law as the “regulatory part”
at Article 31.1), deriving from the terms
of reference of the concession, and those
“contractual” provisions that are agreed
between the conceding authority and the
concessionaire in addition to, and consistent
with, the mandatory provisions (the regulatory
part) of the contract (Article 28).
The conceding authority may unilaterally
amend the regulatory part of the concession
contract at any time, where “exceptional
circumstances relating to the national or local
interest (...)” so justify (Article 31). Such
a unilateral amendment of the concession
contract is subject to prior notification to the
concessionaire. The concessionaire shall be
entitled to receive promptly “adequate and
actual” compensation from the conceding
authority in respect of any damage incurred
as a result of such a unilateral amendment
of the regulatory provisions of the contract.
The concessionaire may not, however, invoke
the unilateral amendment to the terms of
the concession to suspend performance of its
obligations or seek termination thereof.
The Concession Law does not make a
clear distinction between mandatory and
“contractual” provisions of a concession
contract, and these notions remain effectively
untested under Romanian law. In practice,
and in order to limit the risk of unilateral
amendments to a concession contract by a
conceding authority, it is recommended to
attempt to specify clearly in the contract
those provisions which are deemed to be
of a “regulatory” nature and those of a
“contractual” nature.
Similarly, the Concession Law does not
indicate a basis for the determination
of the “adequate and actual” compensation
to which the concessionaire is entitled,
nor the manner in which such compensation
may be paid to the concessionaire. In this
respect, it will certainly be necessary to
explore the possibility under the Concession
Law to provide, in certain cases, for a
compensation of the concessionaire in the
form of an adjustment to the tariffs paid
to it by users (and/or, where appropriate,
in the form of a revision of the investment
programme undertaken by the concessionaire),
rather than in the form of a “one-off”
indemnity payment, which may not in
all cases be the most appropriate manner
to restore the financial equilibrium of
the concession.17
Financial equilibrium of the concession
Concession projects generally involve
the establishment of a long-term relationship
between the concessionaire and the conceding
authority, that will develop in an often
rapidly changing legal, institutional and
economic environment.
By specifically stating that the “contractual
relationships between the conceding authority
and the concessionaire are based on the
principle of the financial equilibrium of the
concession” (Article 32), the Concession
Law specifically addresses a major issue
of concern for concessionaires.
Pursuant to Article 32, the financial
equilibrium of the concession consists in
the “realisation of a possible equality between
the advantages granted to the concessionaire
and the charges imposed upon it.”
As a result, Article 32 continues:
“(...) the concessionaire shall not be obliged
to bear the increase of charges in relation
to the performance of its obligations,
where such increase results: (a) from an
action or measure by a public authority;
or (b) from Force Majeure or a Cas Fortuit.”18
11 Article 25 of Law No. 15/1990 provided that the
annual concession fee could not be less than
whichever was greater between: (i) the amount
equal to 5 per cent of the net profit resulting from
the operation of the relevant assets or service in
the five years preceding the granting of the
concession; and (ii) the amount that is equal to
the interest that would accrue on “the estimated
value of the concession” calculated by using the
“base rate of the National Bank of Romania”.
12 In several respects, the methodological norms
for the implementation of the Concession Law
are in fact less developed than the Concession
Law itself.
13 See also Article 9 of the methodological norms.
14 If an open or closed tender does not result in the
selection of a winning tenderer, a new tender
must be organised within 45 days of the end of
the first tender (Article 19). It is only upon a
failure of the second tender procedure that a
tender is deemed unsuccessful for the purposes
of Article 26.
15 Article 18 of the Law specifically refers to the
following criteria: (i) the amount of investments
undertaken by the tenderer, (ii) the “price of the
services”, (iii) their “cost”, (iv) environmental
protection and social considerations, (v) the
professional and financial track record and
guarantees of the tenderer, and (vi) the terms and
conditions of the implementation of the tenderer’s
investment programme. An indicative model listing
certain selection criteria is provided in an Annex 1
to the methodological norms for the
implementation of the Concession Law.
16 They are completed by the provisions of Articles
47-72 of the methodological norms.
17 This not least because in most of the cases
the conceding authority will not have sufficient
funds to be able to pay an indemnity to the
concessionaire.
18 A civil law concept close to the notion of force
majeure.
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The introduction of the concept of
financial equilibrium of the concession
in the Concession Law and the statutory
confirmation of the possibility for
concessionaires to invoke the classic “change
in law’’ and “force majeure’’ concepts of
international concession projects certainly
constitute a substantial improvement, and
are likely to bring comfort to concessionaires
entering concession contracts with the
Romanian State or local authorities.
It remains to be seen, however, how the
concepts of “action or measure” by a “public
authority” will be construed in practice, and
in particular, whether the term “measure”
(mâsurâ) will cover changes in laws and
ordinances or will be limited to subordinated
and/or discriminatory regulatory measures
taken by Romanian public authorities. In this
respect, while it would appear that the “public
authority” referred to in Article 32 (autoritate
publica) is any Romanian public authority
and not only the conceding authority, it is
very uncertain that such terms could be
construed broadly to cover the Parliament.
The question also arises whether the grounds
for adjustment referred to in paragraphs
(a) and (b) of Article 32 are limitatively listed
in the Concession Law, or whether the list
can be contractually expanded, for example,
to cover certain material changes in
macroeconomic conditions that cannot be
factored in tariff formulas (circumstances of
hardship or “imprévision”19).
Categorisation of assets
Upon expiry or termination of the concession,
for any reason, the concessionaire shall
return and hand over to the conceding
authority the public property granted in
concession, together with all new facilities,
equipment and other improvements accrued
as public property resulting from investments
made by the concessionaire during the
concession period (Article 29).
In this respect, inspired by a classic
categorisation of French concession law,
the Concession Law requires that the
concession contract clearly identify and
distinguish among:
■ public and private property assets granted
in concession and those resulting from the
investments made by the concessionaire
during the concession period in accordance
with the investment plan set out in the
terms of reference of the concession and
incorporated in the concession agreement
(bunuri de retur);
■ those assets owned by the concessionaire
and used by it in the operation of the
concession, which may be purchased by
the conceding authority at net book value
upon termination of the concession (bunuri
de preluare); and
■ those assets owned by the concessionaire and
used by it in the operation of the concession,
other than those purchased by the conceding
authority upon termination (bunuri proprii).
The implementation of concession projects
has long been impaired by the lack of clear
constitutional or legal definition of public/
private property. Although the new Law
“on Public Property” will not remove all
difficulties in the identification, and the
allocation among national and local public
authorities of public property, it will bring
certain clarification to the definition and
legal regime of public property in Romania.
There will remain uncertainties, however.
Therefore, in order to limit the scope for
discussions and disputes, and in compliance
with Article 29, it is recommended, here
again, to attempt to identify as specifically
as possible in the contract, based on the
criteria set forth in the new Concession Law:
(i) the list of those assets belonging to the
public and private property of the conceding
authority granted in concession and of those
investments of the concessionaire that will
accrue to such public property; and (ii) the
list of those assets of the concessionaire
affected by the concession that are deemed
to be the concessionaire’s own assets, including
those assets that may be purchased by the
conceding authority upon termination of the
concession and those that will remain with
the concessionaire after termination.
Termination
The Concession Law provides in its Article
28(5) that the parties shall agree upon the
terms and conditions of the termination of
the concession contract and that they may
agree on specific provisions concerning the
unilateral termination or “repurchase” of
the concession (by the conceding authority).
The Concession Law, however, provides
that a certain number of statutory grounds
of termination must be included in the
concession contract (Article 35).
These statutory grounds for termination are:
■ the expiry of the concession contract
upon its term;
■ the case where the national or local interest
justifies the unilateral termination of the
contract, in which case the conceding
authority shall be liable for the payment
of a fair and preliminary compensation
(despagubiri) to the concessionaire;
■ the breach by the concessionaire or the
conceding authority of their respective
obligations under the concession contract,
in which case the conceding authority or
the concessionaire shall be entitled to
terminate unilaterally the contract and be
indemnified by the breaching party;
■ the destruction of the public property
granted in concession as a result of force
majeure, or otherwise the “impossibility for
the concessionaire to operate the relevant
public property”, in which case neither the
concessionaire nor the conceding authority
shall be entitled to compensation.
The terms and conditions applicable to the
cases of termination as set out in Article 35
are mandatory so that the parties may not
limit in the concession agreement their
obligations arising under Article 35. In
particular, the concessionaire may not seek
more favourable terms of indemnification,
or limit its liability in any manner in the case
of termination for its own breach. However,
pursuant to Article 72 of the methodological
norms for the implementation of the
Concession Law, the list set out in Article 35
can be contractually expanded by agreement
of the concessionaire and the conceding
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authority. The parties could stipulate, for
example, that in addition to the cases provided
under Article 35, the concession agreement
can be terminated if certain other material
project contracts related to the concession are
terminated (e.g., certain financing agreements
or, possibly, an off-take agreement).
It must also be noted that Article 35 does
not expressly state the terms upon which
the concessionaire shall be indemnified by
the conceding authority in respect of the new
or renewed public assets financed by it
(“bunuri de retur”) where the concession
agreement is terminated before its term.
While it is generally accepted that the
enrichment procured by the concessionaire
to the public domain of the conceding
authority must be compensated in any case,
the Concession Law does not give any
guidance as to how such compensation shall
be calculated. In this respect, it remains to be
seen in particular whether Romanian courts
will adopt the principle that the amount of the
compensation payable to the concessionaire in
such a case shall be based on the net book
value of the relevant public assets at the time
of termination, or whether they will allow
for other calculation methods such as, for
example, calculations based on the amount
of the financial debt of the concessionaire20
outstanding at the time of termination.
Conclusion
This overview of the Concession Law does
not, obviously, address all issues raised by
the structuring and implementation of a
concession project in Romania today. Beyond
the sometimes unclear or inconsistent terms
of the Concession Law, there remain further
substantial clarifications and reforms to be
brought to the Romanian legal framework
to allow for a smooth implementation of
concession projects in Romania, including
improvements to tariff regulations, tax and
accounting laws and public finance rules,
which are beyond the scope of this article.
Nevertheless, in the difficult political and
economic context Romania is currently
facing, it can only be seen as a success that
the Parliament passed the Concession Law,
which is crucial for the development of
private participation in the much-needed
rehabilitation and development of utilities
and public services in Romania. Combined
with the Law “on Public Property”, the Law
“on Local Public Finance” and, when
adopted, the Law “on Local Public Services”,
the Concession Law will bring significant
improvements to the reliability and
consistency of the legal framework applicable
to concessions and should foster the
structuring and development of new
concession and BOT projects in Romania.
19 A civil law concept often compared to the common
law concept of “frustration”. Imprévision does not
require that the relevant event (generally a change
in macroeconomic conditions) prevents the
performance of its obligations by the person
affected by it but that it renders such
performance unduly onerous. The event shall
have been unforeseeable at the time of the
conclusion of the contract and be beyond the
control of the parties.
20 That is, the debt taken on by the concessionaire
for the purposes of financing investment in the
development and/or renewal of the conceding
authority’s public domain.
* The author would like to acknowledge with
gratitude the assistance provided by Florentin
Tuca and Sorin Mitel, partners at Musat &
Associates (Bucharest), for their contribution to
this article.
Michel Lequien
Senior Associate
Ashurst Morris Crisp
22 rue de Marignan
75008 Paris
France
Tel: +33 1 53 53 53 53
Fax: +33 1 53 53 53 54
E-mail: [email protected]
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Mira Davidovski, Partner, Salans Hertzfeld & Heilbronn*
Restructuring and recoveringdebt from insolvent Russianfinancial institutions
In this two-part series, the legal framework available in late 1998 and early
1999 to deal with the collapse of the Russian banking sector is analysed.
The first article (published in the last issue of Law in transition) focused
on the tools available to creditors to attempt debt recovery and damage
limitation in relation to bank debts in the “pre-bankruptcy phase”, that is,
prior to the revocation by the central bank of a bank’s banking licence.
The present article discusses the two major additions to the legal framework
for managing bank insolvency: the Law on Insolvency of Credit Organisations
(the “Bank Insolvency Law”) of March 1999, and the Law on Restructuring
of Credit Organisations (the “Restructuring Law”) of July 1999.
Introduction
The enactment of the Bank Insolvency Law1
in March 1999, following extended political
debate, provided some aid to courts in
dealing with the particularities of bank
bankruptcies, as did secondary regulations of
the central bank which have emerged
throughout 1999. At the same time, the
political and administrative dilemma of the
central bank and government, evidenced by
the reluctance to close down large numbers
of banks at once, could not be resolved by
the Bank Insolvency Law. Indeed the slow
pace of bank licence revocations,
prerequisite to opening bankruptcy
proceedings, continued after March 1999.
For creditors, it was of paramount importance
for the government to begin to intervene
in the financial collapse by imposing a state
monitored and organised process of bankruptcy.
This would offer the hope of equal and
transparent treatment to holders of claims
against failing banks, and of curbing the
process of private deal-making and asset-
stripping. It could be achieved by revoking
licences or, in part, by instituting temporary
administrations in failed banks, with enough
legitimacy to wrest control of those institutions.
On the other hand, for government
authorities, numerous licence revocations
would have led to the dismantling of the
banking infrastructure at a time when the
economy’s banking and capital investment
needs remained vastly unmet, without
having in place a plan for reconstructing
a minimally adequate financial network.
Similarly, forcing the central bank to impose
temporary administrations on a large number
of failed banks would have severely strained
its resources and tested the authorities’
political will to challenge the powerful and
independent interest groups standing behind
the largest failing banks. During this period
of indecision, the ad hoc restructuring
that did occur was private, non-transparent
and encouraged by the release of stabilisation
credits from the central bank.
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The Restructuring Law2 of July 1999
introduces a full, state-managed restructuring
phase, preceding liquidation, for a limited
class of banks, giving the the government
the opportunity to rebuild a part of the
banking infrastructure in a way that may
more closely conform to its policy aims.
Significant powers of implementation and
control over the restructuring process are
granted to a new federal agency, the Agency
for Restructuring of Credit Organisations
(ARCO). In theory, the conflicting goals
of managed liquidation, championed
by creditors, and rehabilitation, supported
by policymakers, are accommodated in
the policy compromise represented by the
Restructuring Law, though only for a limited
class of banks. However, the law does
not address the ongoing dilemma of how
to manage fairly and with dispatch the
liquidation of the majority of insolvent banks.
ARCO was transformed by the Restructuring
Law from a non-banking credit organisation
into a government non-commercial corporation
with some bank powers. As such, it is the
successor in full of the prior agency (which
was established soon after the banking
crisis in 1998) and will continue to
implement those restructuring plans which
were approved and commenced prior to
enactment of the Restructuring Law, even
if non-compliant with it.
Scope of application of theRestructuring Law and BankInsolvency Law
Restructuring Law
Under Articles 2.3, 3 and 10.4 of the law,
the eligibility of credit organisations for
ARCO assistance is measured on three
levels, namely:
■ the national or regional significance of
the bank, measured by assets and/or
deposits (the “size test”)
■ the degree of its inability to perform,
involving both failure to pay debts
and the depth of capital inadequacy
(the “non-performance test”)
■ the ability of ARCO to help.
First, the institution’s banking assets must
be sufficiently significant. Troubled banks
are eligible for such assistance if for a
six-month period they satisfy criteria based
on the size of their assets (1 per cent of
national banking sector assets or 20 per cent
of regional banking sector assets), or their
share in retail banking deposits (1 per cent
of individual deposits nationally or 20 per
cent regionally).
Second, the institution must be sufficiently
non-performing. A credit organisation may
be placed under ARCO management if both
prongs of the non-performance test are met:
(i) its capital adequacy ratio, the measure
by which regulators monitor the sufficiency
of its aggregate capital, does not exceed
2 per cent (the “capital adequacy criterion”),
calculated in accordance with the Law
on the Central Bank, and (ii) it fails to meet
its obligations to creditors, or to meet
mandatory payment obligations, within
seven days of such obligations coming due,
and such failure results from absence or
insufficiency of funds on its correspondent
accounts (the “payment failure criterion”).
Central bank recommendation. The central
bank must recommend to ARCO that the
bank be placed under management within
seven days of receiving “reliable confirmation”
that the size and non-performance tests are
met, unless the bank is taking legislatively
mandated steps to avoid bankruptcy specified
in the Bank Insolvency Law. Under that law,
these preventive measures include
self-managed financial rehabilitation,
reorganisation, or submission to temporary
administration by the central bank.
ARCO must accept – in its sole discretion –
to take the institution on. ARCO may
refuse to place a credit organisation under
management if (i) doing so would not be
in accordance with ARCO’s organisational
or financial capabilities, (ii) it determines
that restructuring measures would be
ineffective, (iii) the credit organisation
does not meet the criteria for restructuring
(set out in Article 3, as described above),
or (iv) there are no grounds for restructuring
the credit organisation. ARCO is granted
90 days to make this evaluation. If ARCO
refuses to take restructuring measures,
it must notify the central bank the following
day, and the central bank must within
15 days revoke the credit organisation’s
banking licence if grounds for revocation
(as set forth in the Banking Law3) exist.
Notably, the ground for licence revocation
specified by the Banking Law, relating
to payment failure, is set at the 30-day mark.
Conceivably, in the unlikely event that
the other grounds for licence revocation
are absent, a bank that was failing
to pay debts within seven days might be
granted an interim period prior to revocation.
Discretion on this point still lies with
the central bank. Once an institution
meets the first and second measures
of eligibility, the central bank must direct
them towards either rehabilitation at the
option of ARCO, or (unless the grounds
for revocation are absent) to liquidation
by judicial procedure. This represents
a new dimension of legislative control
on the exercise of the central bank
discretion and could portend increased
licence revocations.
1 Law No. 40-FZ of 25 February 1999 “on
Insolvency (Bankruptcy) of Credit Organisations”;
entered into effect on 4 March 1999, save for
Articles 6, 19, 25.2, which entered into effect on
1 March 1999, and Article 52, which entered into
effect on 1 September 1999.
2 Law No. 144-FZ of 8 July 1999, signed into
law by President Yeltsin on 9 July 1999 and
officially published and entered into force
on 13 July 1999.
3 Law No. 17-FZ “on Banks and Banking Activities”
of 3 February 1996, as amended by Law
No. 151-FZ of 31 July 1998, Law No. 136-FZ
of 8 July 1999, and Law No. 137-FZ dated
8 July 1999.
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Bank Insolvency Law
The Bank Insolvency Law envisions two
categories of measures for troubled banks,
one dealing with rehabilitation measures
which the banks are required to implement
themselves, the other with other measures
implemented by a central bank temporary
administration.
Self-implemented rehabilitation. Grounds
for mandating self-rehabilitation include
violation of the central bank minimum ratios
for capital adequacy and liquidity, a decrease
in capital assets of more than 20 per cent, as
well as a certain degree of payment failure.
While the payment failure threshold for
ARCO management is seven days, here it is
set at three days in most cases, reflecting
perhaps a less advanced stage of instability.
Central bank temporary administration.
The central bank may (but need not) impose
its own temporary administration, an
independent management body, within a
failing bank if any of five grounds are present.
These are: violating the central bank liquidity
ratio by more than 20 per cent in the prior
month, a decrease in capital assets of more
than 30 per cent together with violation of
other central bank ratios, failure to carry out
self-implemented rehabilitation, grounds
permitting licence revocation, and again, a
specified degree of payment failure. Here,
the threshold is seven days, identical to that
for ARCO management, indicating that banks
qualifying for either ARCO management or
central bank temporary administration must
reach this level of non-performance before
state intervention is feasible. These grounds
show a relatively deeper degree of illiquidity
and instability than those that trigger the
obligation to implement rehabilitation and
reorganisation on an independent basis.
The obligation to self-rehabilitate, or the
power of the central bank to impose an
ordinary temporary administration under
the Bank Insolvency Law, can arise in
relation to banks of any size or relative
national and regional importance.
Limits on ARCO activity
Two factors will limit ARCO’s impact on
the restructuring of the banking sector.
One factor is the extent of ARCO resources
and what proportion of these has already
been committed. Pre-Restructuring Law
commitments include rehabilitation without
mandatory take-over of a handful of small
and medium-sized banks, as well as a
Rb 1 billion-loan to Alfa Bank for the
purpose of restructuring regional networks.
ARCO also committed to the negotiation
of rehabilitation plans for two major banks,
Rossiyskiy Kredit and Promstroibank.
Together these commitments approximate
at least 2 billion roubles, one-fifth of the
Rb 10 billion capital of the agency.
Another significant factor for estimating how
broad ARCO’s impact may be relates to the
capital adequacy threshold for application
of the Restructuring Law. Currently, under
central bank standards, the reference point
for a compliant bank (without considering
the other norms) is a capital adequacy ratio
of 8 to 9 per cent. The capital adequacy
criterion of the non-performance test for
eligibility under the Restructuring Law, as
we have seen above, is 2 per cent. This gap
explains in large part the reason why many
banks will never come under the scope of the
new law, which is apparently aimed at
salvaging the remains of those banks whose
capital has sunk to extraordinarily low levels.
Mandatory take-over
The key to the mandatory nature of rehabil-
itation under the Restructuring Law is that it
places shareholder control of the insolvent
bank with ARCO, seizing by legislative fiat
the insider control that has eluded the
regulators thus far. Article 4 provides:
“For purposes of this federal law, the term
‘under management of the Agency for
Restructuring Credit Organisations’ shall mean
the implementation of measures to restructure
credit organisations in conditions which permit
the Agency to determine the decisions of the
credit organisation on questions within the
competence of the general assembly of its
founders (participants), including on questions
of its reorganisation or liquidation.”
Under Russian corporate law a vote of 75 per
cent of the shareholders or participants is
required to pass a vote on reorganisation or
liquidation. This provision is read to mean
that ARCO must take over control of 75 per
cent of the shares or participatory interests
in the bank. At the same time, the provision
is sufficiently general to embrace control by
management contract or other means.4
Therefore, ARCO appears to have a choice
of methods for establishing control over
the insolvent bank. Article 10 merely
provides that if ARCO decides to take the
bank under management, it “may” announce
a decision to decrease its charter capital
to the level of its capital assets, and if these
are negative, it may reduce the charter
capital to one rouble.
Comparison between the Bank Insolvency andRestructuring Laws
Duration
The duration of ARCO’s intervention can be
as much as three to four years, preceded by
the 90-day investigatory phase. By contrast,
central bank temporary administration has
a term of 6 months, which can be extended
to 18, but only after licence revocation.
Removal of management and staff
As well as taking ownership control of
a bank, ARCO has the right to remove
from their duties both management and
staff for a period of up to one month. Their
contracts must be revoked in accordance
with the provisions of the Labour Code,
taking into consideration the specialised
provisions of the Restructuring Law, which
among other things envision termination
of salary and a severance payment of
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up to 20 times the minimal monthly wage.
During this period, ARCO’s activity is
impeded neither by shareholders nor by
management of the failing bank. In addition,
ARCO may decide only to limit the powers
of management. The recent order of the
central bank concerning SBS Agro instructs
the temporary administrator appointed to
consider this question: whether to permit
management, other than the chairman of
the management board, to remain present
in the bank.
Moratorium on payments
From the onset of ARCO management,
a 12-month moratorium on the bank’s
repayment of monetary indebtedness or
making of mandatory payments (tax, social
fund payments) is imposed. The period
extends from the date of ARCO’s decision
to impose management for a period of 12
months, but may be extended by ARCO for
up to 6 months, or reduced by ARCO,
upon public notice.
The extent of a moratorium on payments
imposed within central bank temporary
administration under the Bank Insolvency
Law (3 months, no extension) is less than
under the Restructuring Law (12 to 18
months). This limited moratorium may be
imposed only if (i) the powers of management
have been suspended, and (ii) the bank
has failed to meet its obligations for more
than seven days after coming due – that is,
the temporary administration was imposed
in the presence of this circumstance, and
not merely as a result of the violation of
various central bank ratios. Regulation No.
81-P, released by the central bank on
14 July 1999, sets out the procedure for
the review of petitions for moratoria by
temporary administrators.
Suspension of contract performance
ARCO may, in its discretion, refuse to permit
the bank to perform contracts on the grounds
established in the General Bankruptcy Law.
Similarly, where management’s powers have
been fully suspended under the Bank
Insolvency Law, the central bank temporary
administrator may also suspend performance
on contracts on the grounds specified in the
General Bankruptcy Law. According to
Article 77 of that law, an administrator under
the regime of external administration may
suspend the performance of executory
contracts if:
■ performance of the contract by the debtor
would occasion harm to the debtor by
comparison with analogous contracts
concluded under comparable
circumstances;
■ the contract is a long-term contract (with
a term exceeding one year) or based upon
receipt of positive results for the debtor
only in the long term;
■ there are other circumstances impeding the
revival of the debtor’s solvency.
Invalidation of transactions
ARCO banks
The nature of ARCO’s power to invalidate
certain suspect transactions entered
into by an ARCO-managed bank differs
from that used to invalidate transactions
under the Bank Insolvency Law (in turn
based upon the General Bankruptcy Law)
in two respects. First, it has a retrospective
reach of three years, as opposed to six
months, a significant extension of the risk
period for creditors. Second, the
Restructuring Law’s invalidation provision
targets the granting of preferential terms
to the bank’s affiliated entities, rather than
targeting preferential satisfaction of some
creditors over others. The Restructuring Law
does not include a cross-reference to these
other statutes, but introduces independently
two bases on which the administrator may
petition a court to invalidate past contracts.
He may seek invalidation:
■ on any ground envisioned by civil
legislation, or
■ in the case of a transaction entered into
with an affiliated person, if the terms of the
transaction envision receipt by the
affiliated person of a significant preference
by comparison with analogous transactions
concluded in accordance with the trade
usage at that time.
While the risk period for invalidation has
been lengthened for counterparties of an
ARCO bank, those which are not affiliated
with the bank are in a better position than
under the Bank Insolvency Law and the
General Bankruptcy Law.
Non-ARCO banks
In a central bank temporary administration,
the power to invalidate transactions of
the bank is based upon those criteria set
forth in the General Bankruptcy Law
(Article 28 of the Bank Insolvency Law).
These include invalidation under Articles 60,
78 and 101 of the General Bankruptcy Law.
Under both laws, creditors of banks should
note that certain classes of transactions
may be judicially challenged by the
administrator before a bankruptcy proceeding
is even initiated. This risk continues after
the bank passes into a bankruptcy
proceeding, if, in the view of the central
bank, licence revocation is appropriate
notwithstanding the conduct of financial
rehabilitation measures or a six-month
temporary administration.
The separate bases for invalidation,
arising under the General Bankruptcy Law,
are presented at consecutive stages of
the proceeding.
4 Law “on Competition and the Restriction
of Monopolistic Activities on the Commodities
Markets” of 22 March 1991, as amended.
Pursuant to Article 4 of the Antimonopoly Law,
the term “acquisition of shares (participatory
interests) in the charter capital of a company”
means a purchase as well as obtaining
[by the acquirer] of other opportunities,
whether on the acquirer’s own or through its
representatives, to exercise voting rights
pertaining to those shares (participatory
interests), whether on the basis of a trust
agreement, a joint activity agreement,
an agency agreement, or other transactions”.
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Article 60: Observation stage
An administrator may seek invalidation
of contracts entered into after the
bankruptcy petition in violation of limits
on management power.5
Article 78: External administration stage
An external administrator may seek
invalidation:
■ On bases envisioned by the civil
legislation. (As in the first ground for
invalidation given in the Restructuring
Law, this is an invitation to review the legal
enforceability of the debtor’s contracts in
general, but does not introduce a new legal
standard for enforceability.);
■ If concluded with an “interested person”
and if, as a result of performance of the
transaction, creditors have been or may be
damaged. (While a different term is used,
the concept of an “interested person”
parallels the more specific “affiliated person”
standard used in the Restructuring Law, in
that both target a specific class of contracts.
No retrospective period is given, an omission
which creates a rather open-ended risk,
particularly in cases where necessary
corporate approvals for interested party
transactions have been obtained.);
■ If the transaction will bring about the
preferential satisfaction of claims of some
creditors ahead of other creditors, and
has been concluded within six months
preceding the court’s acceptance of the
bankruptcy petition.
Prior to enactment of the Bank Insolvency
Law and the Restructuring Law, it was
doubted whether an Article 78-type
invalidation could reach a credit organisation,
since the General Bankruptcy Law did not
permit external administration for a bank.
While the Bank Insolvency Law and
the Restructuring Law also explicitly and
implicitly, respectively, exclude court-
managed external administration for a bank,
they also represent different kinds of
external administration controlled by the
central bank or by ARCO. Consequently,
the statement in Article 28 of the Bank
Insolvency Law that the bases for invalidation
set forth in the General Bankruptcy Law
apply equally to banks, is fairly interpreted
to reach Article 78.
Article 101.4: Liquidation stage
The liquidation administrator may seek
to invalidate transactions executed by the
debtor, in order to recover the debtor’s assets
from third parties. No standard is given
for the invalidation, so that we can infer
that generally applicable principles of
civil law would be used to determine
whether a transaction should be invalidated.
No retrospective period is identified, which
in conjunction with the lack of a legal
standard, creates troubling uncertainty.
The liquidator’s power is therefore of
concern, as it is so broad as to permit the
liquidator to attack any transaction of
the debtor, entered into at any time, if the
liquidator believes a legal basis can be
given for invalidating it. By the same token,
it is not clear that this type of invalidation,
reserved for the liquidation administrator,
would be available prior to the initiation
of bank liquidation proceedings.
Priority of satisfaction of claims
ARCO banks
Within the context of carrying out
restructuring measures, ARCO is instructed
to satisfy the claims of creditors “in the
procedure and order specified by the
civil legislation” (Article 14.3). Since
the immediate consequence of ARCO
management is a 12 to 18-month moratorium
on payment of creditors’ claims arising
prior to the imposition of management,
it would appear that such claims cannot
benefit from the priority rules set forth in the
civil legislation at least for this moratorium
period. When the moratorium is lifted, as
long as a rehabilitation plan is still in place,
this article suggests that claimants begin
to be paid.
Provided ARCO does not decide to initiate
liquidation as an alternative to rehabilitation,
these creditors should benefit from
the rules of Article 855 of the Civil Code,
governing the priority of processing
payment orders by credit organisations
when funds on an account (in this case
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the correspondent account of the credit
organisation) are insufficient to satisfy them
all. By contrast, should ARCO determine
that liquidation is the only possibility,
under Article 22 of the Restructuring Law,
it would petition the central bank for
revocation of the licence, and if it is revoked,
petition the court for a ruling of insolvency
under the General Bankruptcy Law. Under
the General Bankruptcy Law, Article 106,
remaining assets of the debtor are distributed
in accordance with Article 64 of the
Civil Code.
Non-ARCO banks
By contrast, the Bank Insolvency Law
contemplates the priority satisfaction of
claims only in the context of a liquidation
proceeding. Article 49 of the Bank Insolvency
Law amends the order of satisfaction of
claims in liquidation for a bank, reflecting
the 1996 amendment to Article 64.1 of the
Civil Code, placing bank depositors in first
place. By operation of Bank Insolvency Law
Article 51, the liquidation must occur under
the provisions of the General Bankruptcy
Law (Articles 106, 110), accommodating
this addition.
The main difference between pre-liquidation
and post-liquidation priorities in the Civil
Code is that prior to a determination of
bankruptcy and liquidation, secured
creditors’ claims are met after claims for
mandatory payments (e.g., taxes and social
funds). After a liquidation determination,
secured creditors are satisfied ahead of
claims for mandatory payments, but behind
depositors and individuals with claims for
wrongful injury, and wage claims.
Overall, if a rehabilitation plan proves
sufficiently effective to allow the satisfaction
of creditors’ claims after the lifting of
the 12 to 18-month moratorium – that is,
if ARCO does not use its power to terminate
the plan and request liquidation – then
the government is rewarded by maintaining
its priority in the pre-liquidation order
over secured creditors.
Rehabilitation plan
ARCO banks
ARCO must present a rehabilitation plan
which can include various options, but must
envision completion within three years.
With central bank consent, this period can
be extended by 12 months. Among the
powers in ARCO’s arsenal are (i) replacing
management and staff, (ii) seeking the
invalidation of past transactions, (iii) sale
of assets by public auction for most assets,
or private sale for selected assets, (iv) sale
of the bank as an enterprise, (v) transfer of
assets to a new bank which is granted very
lenient conditions for establishment, and
(vi) sale of ARCO shares in the bank.
The only requirements imposed on every
rehabilitation plan are that it must propose
(i) measures for the restructuring of the
liabilities of the bank, (ii) measures
permitting the bank over time to accumulate
and set aside resources for mandatory
reserves, and (iii) measures permitting the
bank to comply over time with prudential
ratios set by the central bank.
Disposition of assets
Article 18 of the Restructuring Law sets
brief guidelines for the disposition of bank
assets during restructuring. Assets selected
for disposition must be evaluated by an
independent appraiser, which brings into
play the recently enacted Law on Appraisal
Activity. Most assets are to be offered in
public auctions, which may be conducted by
ARCO or under contract by an independent
auction organisation. Those whose circulation
is limited by law may only be offered in
closed auctions where the participants are
entities empowered by law to take title to
such restricted assets, such as precious
metals or “restricted securities” (e.g., shares
in other banks or specific companies like
RAO Gazprom).
The sale of the bank itself as a business
entity, or the sale of any one or more branches,
divisions, subdivisions, or departments, is
governed by Article 19 and the corresponding
provisions of the General Bankruptcy Law
(Articles 86, 87, 112.5). The Restructuring
Law specifies that the sale of the bank
or any of its divisions in this context shall
occur without the participation of either the
creditors’ meeting or committee (the term used
in the General Bankruptcy Law) or the
creditors’ union (the term used in the
Restructuring Law). Therefore, the General
Bankruptcy Law obligation to seek approval
of the creditors for the terms of a tender or,
by implication, for inclusion of the sale
in the rehabilitation plan, would apparently
not apply to ARCO. This power is another
example of the broad discretion granted
to ARCO, particularly in the first 12 months
of restructuring.
Restructuring liabilities and
amicable settlement
Since invalidating transactions and
disposing of assets can only go so far in
rehabilitating a bank, and indeed in reducing
its burden of liabilities, one of the most
critical aspects of the rehabilitation process
is ARCO’s power to seek settlement with
creditors. ARCO’s ability to release a bank
into liquidation by asking the central
bank to revoke its licence provides ARCO
with great leverage to extract settlements
from creditors.
ARCO is given one month, from the
commencement of its management, to submit
to the creditors a proposal for the restructuring
of liabilities, and the creditors are then
given 45 days to respond. Refusal to agree
results in the creditors receiving the
liquidation value of their claims over the
anticipated liquidation period. A plan for
5 Article 5.1 of the Bank Insolvency Law resolves
the debate over whether a bank may, after
undergoing a central bank temporary administration,
undergo the “observation” stage in a full
bankruptcy proceeding, by listing observation
as one of the applicable stages.
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restructuring (discounting, converting,
writing off, or otherwise repackaging)
liabilities will be evaluated by creditors
by comparing the size of the write-off in the
plan with what they may be forced to take
in liquidation.
If these time periods are observed, claimants
may expect within approximately six
months an indication of whether a deal with
creditors to write down debt will succeed,
or alternatively, whether the remaining
assets will be distributed in liquidation.
Since Article 5.2 of the Bank Insolvency Law
prohibits a court overseeing the bankruptcy
of a credit organisation from applying
provisions of the General Bankruptcy Law
dealing with amicable settlement (or external
administration) to a credit organisation,
the ARCO proposal for settlement is the
only route to achieving a global reduction
of debt by agreement of the creditors, outside
of private negotiations.
Creditors’ rights have been altered as well.
The assembly of creditors (the “creditors’
union”) includes both private and
governmental claimants, whereas under the
General Bankruptcy Law, the meeting of
creditors automatically includes qualified
private creditors, allowing the participation
of governmental claimants only in specific
cases. Disputes between the creditors and
ARCO over the size or priority of their claims
(both private and governmental) are resolved
by an “organ created by the creditors’ union”,
as compared to the right of qualified private
creditors under the General Bankruptcy
Law to appeal to a court to resolve disputes.
In voting on a proposed settlement agreement,
ARCO may represent both the federal
government and regional governments if so
appointed. It is not clear whether procedures
for managing potential conflicts of interest
will be promulgated.
Non-ARCO banks
A fundamental difference between the
Restructuring Law and the Bank Insolvency
Law is that, during the ARCO management
period, the former combines the elements
of an external administration and specific
rehabilitation measures. The Bank
Insolvency Law presents self-implemented
rehabilitation and outside administration
as two consecutive and independent phases.
Insofar as the first stage is concerned, a
bank must carry out a financial rehabilitation
plan within an ad hoc period set by the
central bank.
The financial rehabilitation measures
that satisfy the law are: obtaining financial
assistance from the shareholders, founders
or third parties, restructuring assets and
liabilities, changing the organisational
structure of the bank, and “others carried
out under the law.”
Financial assistance comprehends the
receipt of loans bearing interest no higher
than the central bank refinancing rate
with a term of at least six months; receipt
of sureties or guarantees for loans to the
bank; receipt of extensions on repayment
of debt; transfers to third parties of debt
with creditor consent; refusal to distribute
profits as dividends and application of
such resources to rehabilitation; contributions
to capital; forgiveness of indebtedness;
and novation. Bank Insolvency Law Article
8.2 permits funds which are on deposit
in a bank to be used by the creditors owning
those funds to contribute to, and increase, the
capital of the bank. Since this encompasses
funds sourced outside the bank, as well
as loans made by the bank, it is suspected
that this provision is used at times by banks
to distribute resources to affiliated entities
which then contribute the loaned funds
back to charter capital.
A financial rehabilitation plan including
these methods is triggered either by
mandatory request of the chairman of the
bank, or by direct intervention of the central
bank. Detailed regulations on the
implementation conduct of measures for the
prevention of bankruptcy appeared in central
bank Instruction No. 84-I of 12 July 1999.
Some procedures for monitoring the degree
of banks’ payment failures were promulgated
as well in by Directive No. 620-u on
4 August 1999.
“Newco” banks
Article 20 of the Restructuring Law implements
one of the methods favoured since 1998 by
the central bank for rebuilding the banking
sector: the creation of new banks from the
ashes of the old. ARCO may create “newco”
banks, in which ARCO is the sole founder,
in the context of rehabilitation. The assets
and liabilities of the restructuring bank may
be transferred to the new bank, and although
compensation paid for the assets must be
applied to the satisfaction of creditors’
claims, and the value of the assets must be
established by independent appraisal, these
provisions do not specify payment. Debts
can be transferred “in accordance with the
requirements of civil law” thus implying the
consent of the creditors. The new bank must
have charter capital satisfying the minimum
capital for a non-banking credit organisation,
which as of 1 July is set at Û100,000
(except for subsidiaries of foreign banks).
Moreover, the Restructuring Law and the
contemporaneous amendment of Article 11
of the Banking Law permit ARCO to make up
the capital with borrowed funds, which is
ordinarily prohibited for banks. An element
of external control applies insofar as the
central bank may refuse to issue the banking
licence if it believes the proposed chairman
or chief accountant does not conform to the
criteria of the Banking Law. The newco
banks are exempt from various requirements
in the Banking Law, and are to be regulated
by instructions yet to be issued by the
central bank.
Recent developments in restructuring liabilities
Conversion of debt to equity. This method
of reducing liabilities has been strongly
recommended by the central bank, first in its
outline for restructuring the banking system,
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then in the April address to the Association
of Russian Banks, and lastly in central bank
regulations that appeared in late March.6
The instruction specifies that a joint-stock
credit organisation may, with the consent of
its creditors, exchange all or a portion of its
obligations for bonds convertible into shares
of that credit organisation (Article 1). Bonds
(and shares upon conversion) must be issued
in accordance with the requirements of
Instruction No. 8 dated 17 September 1996,
on Rules for the Issue and Registration of
Securities by Credit Organisations on RF
Territory. The bonds must be denominated
in roubles, and prior to issue, the credit
organisation must have in its charter
sufficient authorised but unissued shares to
cover the possibility of conversion. It should
be noted that bond issuance is limited by
Article 33 of the Law on Joint-Stock
Companies to the amount of a joint-stock
company’s charter capital.
Foreign creditors, even if they wish to take
equity in exchange for their debt claims,
face a quota on bank investment. Limits
on foreign shareholdings in Russian banks
are established both for the banking sector
as a whole, by means of a quota, and for
individual banks, by means of transfer
restrictions. The current quota of 12 per cent
was reportedly filled to the 5 to 6 per cent
level in early 1999, although several foreign-
owned banks had announced capital
increases which would absorb much of
the remainder. In March the central bank
suggested that the quota on foreign bank
capital be lifted from 12 per cent to between
20 and 25 per cent. But the Banking Law
has not been amended to accommodate this.
Moreover, it still requires credit organisations
or holders of bank shares to obtain the prior
consent of the central bank to any increase
of capital drawn from foreign assets, or to
any alienation of shares to or for the benefit
of non-residents.
Contribution of restructured treasury bills
to bank capital. A method for restructuring
the liabilities of troubled banks which
may be of interest to foreign creditors
appeared in June 1999, and could form part
of a rehabilitation plan either under the
Restructuring Law or the Bank Insolvency
Law. The central bank Decree No. 571-u,
appearing 8 June 1999, now permits investors
in credit organisations to pay for equity with
restructured government treasury bonds.
Path to liquidation
Whether or not a bank has benefited from
an ARCO rehabilitation plan, if efforts to
restructure fail, liquidation occurs following
revocation of the banking licence.
ARCO banks
ARCO may direct a bank into liquidation at
two stages. First, if upon conclusion of the
90-day investigatory phase, ARCO decides
not to take a bank under management,
the central bank must revoke the licence
within 15 days (if grounds for revocation are
present), triggering the Bank Insolvency
Law’s provisions on the opening of insolvency
proceedings. Second, ARCO may at any time
during an ARCO management decide to
liquidate the bank. If the central bank then
decides to revoke the licence, it must post
the bank as undergoing liquidation, and
ARCO must bear the responsibility of
acting as liquidator. This would appear to
encompass circumstances where creditors
can be satisfied with existing assets of the
bank but ARCO believes that the bank
cannot continue to operate.7 Should ARCO
determine that liabilities exceed assets,
ARCO is responsible for submitting a
petition in bankruptcy to the arbitrazh court
under Chapter X of the General Bankruptcy
Law, envisioning accelerated liquidation.
The court is required by law to appoint
ARCO as the liquidation administrator.
In this way, the ARCO bank is barred from
the lengthier procedure under the General
Bankruptcy Law, which would normally
involve an observation period followed by
liquidation, or that offered to other banks
under the Bank Insolvency Law.
Non-ARCO banks
For non-ARCO banks, there is no agency
outside the central bank with any power
to recommend revocation of the licence.
If the central bank’s resources permit
the requisite analysis and in-depth attention,
the central bank may revoke the licence
on the grounds given in the Banking Law,
but there is no guarantee of adequate
resources. The Bank Insolvency Law gives
creditors the right to petition the central
bank to revoke a bank’s licence if indications
of insolvency are potentially present, and
to proceed to a bankruptcy petition if there
is no response in two months. But the court
will dismiss the petition if the second inquiry
to the central bank, this time from the court,
draws a negative answer.
Grounds for licence revocation
Grounds for revocation of a bank licence
which relate in the main to insolvency, were
expanded in July 1998 and are as follows:8
(i) a determination that the licence was
issued on the basis of false information;
(ii) delay of more than one year in the
commencement of banking operations
following issuance of the licence;
(iii) a determination that any periodic
reporting data of the bank contained
false information;
(iv) the carrying out, on a repeated basis,
of operations not envisioned in the
bank’s licence;
6 Instruction No. 527-U of 25 March 1999 “on
the Procedure for Conversion of Obligations for
which a Credit Organisation is the Debtor into
Obligations in the Form of Bonds of the Credit
Organisation Convertible into its Shares”.
7 See Central Bank Regulation No. 264, “on
Revocation of the Licence for Banking Operations
from Banks and Other Credit Organisations” of
2 April 1996, as restated in Directive No. 509-U
of 10 March 1999, and amended by Directive
No. 528-U of 25 March 1999 and Directive
No. 601-U of 7 July 1999.
8 Article 20 of the Banking Law and in Instruction
No. 264.
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(v) the failure to carry out the requirements
of federal laws regulating banking
activity, and normative acts of the
central bank, if, in the course of one year,
disciplinary measures have
been repeatedly applied to the bank
as envisioned by the Law on the
central bank;
(vi) the inability of the credit organisation
to satisfy the demands of creditors on
monetary obligations and/or to carry
out its obligation to make mandatory
payments for more than one month
from their coming due, if the claims
in the aggregate are not less than 1,000
minimum monthly wages;
(vii) a repeated failure to perform, by the fault
of the bank, demands contained in the
judicial enforcement orders to seize
funds from accounts or deposits of clients
at a time when funds were present in
their accounts or deposits.
Ground (vi) reflects the definition of
insolvency for a credit organisation now in
Article 2.2 of the Bank Insolvency Law.
The central bank has the power to revoke the
licence in conditions which are less serious,
– that is, a failure to satisfy debts for seven
days – but since this condition permits the
implementation of central bank temporary
administration under the Bank Insolvency
Law, or, ARCO management if coupled
with the capital adequacy criterion of the
non-performance test, it is unlikely that in
most cases licence revocation would occur
before those avenues are explored.
Conclusion
The Bank Insolvency Law, the Restructuring
Law, and the significant procedural regulations
which have appeared to support them,
represent a net improvement in the legislative
framework for managing the systemic
collapse of the Russian banking sector.
Creditors of major banks that ultimately
come under ARCO management can expect
to be pressed to discount, convert, exchange
and otherwise reduce their debt claims,
receiving, theoretically, a better managed
and more transparent process in exchange.
At the same time, their rights of judicial
appeal during the ARCO restructuring
process have been curtailed. Creditors of
banks that become subject to financial
rehabilitation or central bank temporary
administration continue to face the difficulties
of a more diffuse and less interventionist
process, although they may benefit from a
shorter period prior to liquidation. The scope
for intervention by the central bank outside
these two laws remains broad and discretionary;
the release of stabilisation credits to troubled
banks, estimated at Rb 100 billion from
August 1998 through March 1999, continued
in the summer of 1999 following enactment
of the Restructuring Law.
Comparison of the main features of these
two laws demonstrates the divergence in
methods for dealing with a few especially
significant and deeply bankrupt banks, and
the remainder. ARCO rehabilitation is
proposed to be a serious long-term
intervention for carving out survivors and
sets reduction of liabilities as a priority.
In principle, a similar commitment to
enforced and equitable control of assets
within other failed banks prior to liquidation
would be desirable, whether within the
framework of a specialised law or of existing
laws that give the central bank the power
to intervene. The appearance of the
Restructuring Law cannot deflect attention
from the need properly to implement existing
laws governing most banks, or from the
imperative of equitable treatment for
creditors and depositors, rather than
subordination of their interests to the goal of
recreating the banking sector in a
new image.
In practice, the uneven and in some cases
unskilled implementation of these two laws,
as well as of the General Bankruptcy Law,
have left creditors frustrated and vulnerable
to increasing losses. Claimants must be
prepared to pursue those rights envisioned by
the legislation aggressively and to create
pressure for better application. The adoption
in mid-1999 of standards for licensing and
training rehabilitation and bankruptcy
administrators should raise the quality of
administration to some degree. Recent
attempts of the federal bankruptcy agency to
criminally prosecute individual
administrators suspected of acting in the
interest of insiders, or fraudulently motivated
outsiders, should be encouraged.
The need to support proper liquidation
procedures, as well as restructuring efforts,
remains critical. In the end, the political
consensus required to shut down insolvent
banks remains elusive, and may further be
impeded by preparations for the
parliamentary and presidential elections of
December 1999 and June 2000.
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* Ms. Davidovski practised in Moscow from 1992-96,
where from 1994 she was a resident partner. She
currently divides her time between Paris and
Moscow.
Mira Davidovski
Partner
Salans Hertzfeld & Heilbronn
9, rue Boissy D’Anglas
75008 Paris
France
Tel: +33 1 4268 4800
Fax: +33 1 4268 1545
E-mail: [email protected]
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 24
Focus on
Corporate governance
The term corporate governance does not,
as yet, have a clearly defined legal doctrine
in any system of law. Rather, the term
embodies a range of traditional legal and
non-legal concepts, and applies them to the
business enterprise. As a working definition
that links the following articles, governance
is the system by which an organisation
pursues the over-riding purpose for which
it was established, and avoids pursuing
other purposes. The corporate nature of
governance means that the process applies
when an organisation adopts a corporate
form. It often implies private sector enterprises
but governments also establish and sometimes
participate in corporate organisation.
Although different legal traditions use a
variety of techniques to enable and constrain
activities that are necessary for private sector
enterprise, they tend to depend at a general
level on the legal institutions of property and
contract, supported by standards of civil
liberties and disclosure of information.
On a practical level, this means that the legal
aspects of governance arise in a range of
circumstances. These include, for example,
the design and application of laws for the
organisation of companies; the rules and
disclosure standards of stock exchanges and
securities commissions; the settlement and
clearing systems for securities transfers; rules
on foreign direct investment; accounting
standards; and, at policy level, social security
reforms, which involve the assignment of
former government functions to the private
sector and the separation of the beneficiaries’
interest in the activity from those with control
over it (e.g., pension reform). The articles
which follow are intended to encompass a
wide range of perspectives on corporate
governance, and to encourage a dialogue
which embraces the legal and non-legal
institutions of corporate governance.
The first two articles explain, on the one
hand, the EBRD’s efforts in promoting good
corporate governance in its countries
of operations, and, on the other, the state
of corporate governance in the region as
measured by a legal survey conducted
by the EBRD. The article from BP Amoco
highlights how law influences the governance
of a long-established global corporation
operating in a developed market. In addition,
Professor Wymeersch provides a description
of the share ownership patterns and
governance regulatory techniques that
appear in neighbouring western Europe,
which could provide models for central
and eastern Europe.
The article from CalPERS demonstrates
the importance of legal aspects of governance
for the choice of investment by a long-term
portfolio investor. Foreign direct investment
far exceeds portfolio flows in the EBRD’s
countries of operations, and in that context
lawyers practising in Moscow describe current
governance issues at the heart of any corporate
investment process, namely shareholder
rights and board organisation of joint-stock
companies in the Russian Federation.
In terms of significant institutional reform,
Lucasz Konopielko of the Central and
East European Economic Research Center
highlights how government policy and
regulatory implementation can influence
governance. Lastly, the Legal Transition
Events section contains the OECD’s report
on a recent corporate governance round
table in Moscow, where dialogue has begun
among government regulators, enterprises
and investors in order to explore ways to
enhance governance processes in Russia.
Jonathan Bates
Institutional Design Ltd
E-mail: [email protected]
Hsianmin Chen
Counsel
Office of the General Counsel
European Bank for Reconstruction
and Development
One Exchange Square
London EC2A 2JN
UK
Tel: +44 171 338 6064
Fax: +44 171 338 6150
E-mail: [email protected]
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 25
26
Fo
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Norbert Seiler, Deputy General Counsel, European Bank for Reconstruction and Development*
The role of the EBRDin promoting soundcorporate governance
In recent years, various organisations
and interest groups have been promoting
corporate governance standards. Institutional
investors have been promoting a corporate
governance model focused on the interests
of shareholders. These efforts were mainly
directed at strengthening influence and control
of management action. Other constituencies
have stressed the broader responsibilities of
enterprises towards their various stakeholders
in addition to shareholders, including
employees, suppliers, the community in
which they operate, as well as local and
national governments. The EBRD advocated,
in 1997, corporate governance principles
that recognised the set of relationships
between shareholders, board, management
and other constituencies of a company.1
Following the financial crises in East Asia,
the Commonwealth of Independent States
(CIS) and South America, the articulation
of sound corporate governance standards
has become an issue of acute concern.
In response, the Organization of Economic
Co-operation and Development (OECD)
coordinated and led the development of
a comprehensive set of corporate governance
principles to serve as the primary guidance
in this area.2
As a major lender and investor in enterprises
domiciled in the countries of central and
eastern Europe and the CIS, the European
Bank for Reconstruction and Development
(EBRD or Bank) has always sought to
improve corporate governance standards.
Improving the corporate governance system
of its investee companies is consistent with
the EBRD’s commitment to apply sound
banking principles in all its financial
operations. The Bank is also determined
to ensure that all its operations have
“transition impact”, i.e., they contribute
to the transformation of its countries of
operations from centrally planned economies
to market economies, and by insisting
on good corporate governance the EBRD
assists the transition process. For a large
part of the 20th century, enterprises in
transition countries responded primarily
to the demands of planning agencies.
Many enterprises have only recently
become exposed to the genuine interests
of shareholders and other stakeholders.
The EBRD is also active beyond its
purely financial operations. Good corporate
governance depends on the broader legal
and regulatory environment prevailing
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 26
in the country of domicile of a given
company. Through various law reform
initiatives in its countries of operations,
the EBRD seeks to address these broader
aspects of corporate governance.
The need for an incentiveframework for corporategovernance
Good corporate governance requires internal
control mechanisms and policies, including
means to ensure that staff act in the interest
of the enterprise and do not engage in insider
dealing, disclose proprietary information or
provide credit on grounds other than objective
assessments of potential returns and risks.
Maintenance of good institutional governance
also requires that owners, directors and
senior management are subject to appropriate
sanctions in the event that they disregard
standards of good corporate behaviour.
Good institutional governance is more likely
to be sustained if financial stakeholders
(i.e., minority shareholders, creditors,
depositors) bear some of the cost and effort
of exercising diligent corporate oversight.
In fully developed capital markets,
bondholders and minority shareholders share
a keen interest in exercising corporate
oversight. Likewise, banks in such markets
will operate effective systems for
counterparty appraisal and exposure control.
This also applies to developed interbank
markets, where the prospect for poorly
managed banks of reduced credit lines and
increased risk charges serve as powerful
incentives for good corporate behaviour.
Finally, a key feature of effective corporate
governance systems is that poorly run
commercial enterprises, including financial
institutions, must be allowed to fail. An
effective insolvency regime requires adequate
legislation and effective judicial and
administrative mechanisms.
Shareholders and creditors alike must
understand and be satisfied with the manner
in which financial stakeholders can oversee
the performance of management and
participate in key decisions. As a minimum,
the charter of a company should set out
the basic roles and responsibilities of the
various corporate bodies such as the general
assembly, the supervisory board or board of
directors. In addition, shareholder rights
must be protected against dilution or other
loss of value through inappropriate dealings
and transfer pricing. The integrity of the
shareholders’ registry must be assured.
Protection of shareholders’ rights also
requires the distribution of an annual report
containing properly audited accounts and
other important corporate information.
Towards international standards of corporategovernance: OECD Principles of Corporate Governance
The OECD has been active in the area of
corporate governance for a number of years,
beginning in 1996 with the commissioning
of a study of corporate governance. The study,
which reviewed and analysed international
corporate governance issues and suggested
an agenda and priorities for further OECD
initiatives, led to the establishment of
the Business Sector Advisory Group on
Corporate Governance.3
The OECD Council, meeting at ministerial
level on 27 to 28 April 1998, called upon
the OECD to develop, in conjunction with
national governments, relevant international
organisations and the private sector, a set
of corporate governance standards and
guidelines. In order to fulfil this objective,
the OECD established the Ad-Hoc Task
Force on Corporate Governance to develop
a set of non-binding principles that embody
the views of OECD member countries on
this issue.
The principles contained in the resulting
document4 (the OECD Principles) are built
upon the experience gained from national
initiatives in OECD member countries
and previous work carried out within the
OECD, including that of the OECD Business
Sector Advisory Group on Corporate
Governance. Several OECD committees
contributed to the preparation of the OECD
Principles, as well as non-OECD countries,
the World Bank, the International Monetary
Fund, business groups, investors, trade unions,
and other interested parties. The EBRD
participated in the meetings of the Task Force
on Corporate Governance as an observer.
The OECD Principles seek to strike a
balance between the various, sometimes
conflicting, concepts of corporate governance,
and promulgate standards of good corporate
behaviour under five main headings:
the rights of shareholders, equitable
treatment of shareholders, the role of
stakeholders, disclosure and transparency,
and responsibility of the board.
The core values underlying the OECD
Principles are fairness, transparency,
accountability and responsibility. It is
hoped that the OECD Principles will find
universal application, and will thus facilitate
the development of corporate governance
systems based on these core values
throughout the world.
1 EBRD, Sound Business Standards and Corporate
Practices: A Set of Guidelines (September 1997),
available at the EBRD website at www.ebrd.com.
2 For details, see the OECD website at www.oecd.org.
For discussion of the emerging international
standards-setting process and its components,
see J. Norton, "International financial law and
international economic law: implications for
emerging and transitioning economies", Law in
Transition (EBRD, London, Spring 1999), p.2;
G. Sanders and D. Arner, "The legal anchoring
of sound financial markets", Law in Transition
(EBRD, London, Spring 1999), p.18; EBRD,
Transition Report 1998 (EBRD, London,
November 1998), ch.6.
3 Corporate Governance: Improving Competitiveness
and Access to Capital in Global Markets,
a report to the OECD by the Business Sector
Advisory Group on Corporate Governance
(OECD, Paris, 1998).
4 OECD, Principles of Corporate Governance,
SG/CG(99)5 (OECD, Paris, April 1999)
(available at www.oecd.org).
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The OECD Principles were adopted by
the OECD Council in May 1999. Further,
on 21 June 1999, the OECD and the
World Bank entered into a Memorandum
of Understanding envisaging co-operation
between the two organisations for the
promotion of the OECD Principles in
non-OECD countries.5 (See the Legal
Transition Events section in this issue for
a further description of this co-operation.)
EBRD activities that fostergood corporate governance
The EBRD was established in April 1991
in response to the unprecedented changes
and challenges arising from the central
and eastern European countries’ move from
centrally planned and command economies
to democratically governed market
economies. The Bank was given the mandate
to support this transformation through
the promotion of private and entrepreneurial
initiative in these countries.6
The EBRD accomplishes its mandate primarily
by the financing of specific projects that have
a positive impact on the process of transition.
The Bank’s operational objectives place
primary emphasis on programmes that support
privatisation and the development of a
competitive private sector, with particular
emphasis on investment in infrastructure.7
The EBRD is required to operate in accordance
with sound banking principles.8 At the same
time, the EBRD’s operation is required to be
“additional”: i.e., it is barred from undertaking
any financing where a borrower or client
applicant is able to obtain sufficient financing
or facilities elsewhere on terms and conditions
that the Bank considers reasonable.9 Within
these constraints, the EBRD carries out its
operations in the following principal ways,
in accordance with its mandate:10
■ providing loans to private sector
enterprises and state-owned enterprises
operating competitively to facilitate their
transition to private ownership and control;
■ investing in equity capital of private sector
enterprises, or state-owned enterprises
operating competitively to facilitate their
transition to private ownership and control;
■ underwriting equity and debt issues
of securities;
■ facilitating access to domestic and
international capital markets by enterprises
through the provision of guarantees and
financial advice;
■ providing technical assistance for the
reconstruction or development of
infrastructure.
Sound business standards andcorporate practices – a set of guidelines
As an international institution with the
mandate to assist the transition process
in the countries of central and eastern
Europe and the CIS, the EBRD views the
promotion of sound standards of business
conduct as central to its work. The Bank
published a set of guidelines in September
1997 to help companies understand some
of the broader concerns that lenders and
investors have when considering a potential
loan or investment opportunity in the region.11
The guidelines seek to address concerns of
general importance for any investor or lender,
and therefore discuss areas of concern to
the EBRD when it evaluates investment
and lending opportunities. The guidelines
cover not only fundamental interests of
all shareholders, but also the relationship
between companies and their clients,
suppliers, local communities and governments.
Sound principles of corporate governance
include the existence of a transparent
shareholding structure, respect for the rights
of minority shareholders and a well-functioning
board of directors.
The success of a company in the long term
depends not only on the quality of its
strategy, competent management, valuable
assets and a promising market. Success also
hinges on the quality of the relationships
that the company maintains with the various
constituencies on which it depends:
customers, shareholders, lenders, employees,
suppliers, the community in which it
operates, government and local authorities.
Sound and stable relationships depend on
fair, transparent and responsible practices,
behaviour and standards. Thus the long-term
success of a company and its ability to attract
capital depends on establishing and meeting
these standards.
An essential underlying theme of the
guidelines is the prevention of financial
fraud and avoidance of corruption.
As the guidelines emphasise, it is incumbent
upon companies to promote sound business
practices through their own behaviour.
For example, company boards are encouraged
to adopt a code of ethics for their company,
and executive managers are encouraged
to motivate employees and associates to
adhere to this code.
Raising awareness of reform needs
The EBRD seeks to raise awareness of
policy makers and other interested parties
about the legal, regulatory and market
environment underpinning good corporate
governance in its countries of operations,
in order to stimulate reform. The Bank
also provides law reform assistance to
government agencies.
The EBRD’s Office of the General Counsel
recently conducted a survey about
capital markets and banking supervision
laws in the EBRD’s countries of operations,
which sought to assess to what extent
the laws of these countries approximate
international standards.12
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With regard to banking laws, survey
participants were asked to answer survey
questions based on the Basle Committee
on Banking Supervision’s Core Principles for
Effective Banking Supervision13 in an effort to
ascertain the extensiveness and effectiveness
of the banking laws of their countries
in relation to the relevant international
standard. As to capital markets laws, the
International Organization of Securities
Commission’s Objectives and Principles of
Securities Regulation14 were chosen as
the most appropriate benchmark.
Laws were rated for extensiveness and
effectiveness based on the survey responses,
as “fully”, “strongly”, “moderately”, “weakly”
and “non-conforming” with the respective
benchmarks. According to the survey results,
none of the jurisdictions was rated as “fully
conforming” in the area of either banking
or capital markets law. The capital markets
laws of five countries were rated as “strongly
conforming”, several countries were rated
as “weakly conforming”, and twelve countries
were rated as “non-conforming”. In the
banking supervision area, four countries were
rated as “strongly conforming”, several
countries as “weakly conforming” and seven
countries as “non-conforming”.
As a result of this empirical approach, the
Bank is raising the profile of issues of legal
reform in the region, including in the area of
corporate governance, and is able to focus its
own efforts and resources on areas of most
significant need. (See the following article
for an analysis of survey results focusing
specifically on corporate governance practices.)
Providing legal technical assistance
In the area of corporate governance, the
Legal Transition Team of the EBRD is
currently providing legal technical assistance
to the Russian and Czech securities
commissions. Legal technical assistance
projects for other countries supporting good
corporate governance are in preparation.
Moreover, the EBRD’s Legal Transition
Programme, which combines all its legal
reform initiatives, focuses not only on
company law and securities regulation,
but also on other areas of the law that are
important corollaries to good corporate
governance, such as bankruptcy laws and
secured transactions laws.15
Russia: reform of law on joint
stock companies
The EBRD is currently assisting Russia's
Federal Commission for the Securities
Market (FCSM) in improving the legal
framework for good corporate governance.
The Bank’s legal reform project, funded by
the Japanese Government, aims to facilitate
and promote a well-organised, modern,
efficient capital market in the Russian
Federation, and helps to achieve higher
standards in regulation of corporations and
protection of rights of securities holders.
On the whole, the Russian Law on Joint
Stock Companies, which came into force on
1 January 1996, has provided a solid legal
framework for corporate activity. However,
its implementation has shown some obvious
gaps and some of its provisions require
further adjustment or adaptation. The vital
legislative supplements needed to modernise
Russian corporate law include procedures
governing the liability of directors and
managers, external and internal audits,
transactions with affiliated or connected
persons and general and special meetings.
The only federal law directly concerning
the Russian capital market is the Law on the
Securities Market, which became effective
on 25 April 1996. Other applicable rules are
contained in regulations issued by the FCSM,
and in presidential decrees. However it has
become apparent that rapid development of
the Russian securities market is inadequately
served by the current legal system, and
improved rules are needed to avoid legislative
gaps, lack of clarity and resulting uncertainties
for market participants. The inadequacy of
the present legislative framework affects the
relations between market participants and
the willingness of potential investors to enter
the market. It also prevents the FCSM from
5 Memorandum of Understanding between the
World Bank and the OECD, A Framework for
Co-operation between the Organization for
Economic Co-operation and Development and
the World Bank (Paris, 21 June 1999) (available
at www.oecd.org).
6 The Agreement Establishing the European Bank
for Reconstruction and Development, Art.1.
7 See Art.2.
8 Art.13(i).
9 See Art.13(vii), providing: “the bank shall not
undertake any financing, or provide any facilities,
when the applicant is able to obtain sufficient
financing or facilities elsewhere on terms and
conditions that the Bank considers reasonable”.
10 See Art.11.1.
11 See EBRD, Sound Business Standards and
Corporate Practices: A Set of Guidelines
(September 1997), available at the EBRD
website at www.ebrd.com.
12 The results of the survey and discussion of its
methodology are presented in A. Ramasastry and
S. Slavova, "Market perceptions of financial law
in the region – EBRD survey results", Law in
Transition (EBRD, London, Spring 1999), p.24,
and Transition Report 1998 (EBRD, London,
November 1998), ch.6. The spring 1999 issue
of Law in Transition, the legal publication of the
EBRD, contained a “Focus on financial markets”.
13 Basle Committee on Banking Supervision,
Core Principles for Effective Banking Supervision
(BIS, Basle, 1997).
14 International Organization of Securities
Commissions (IOSCO), Objectives and Principles
of Securities Regulation (IOSCO, Montreal, 1998).
15 For this reason, legal reform in the area of
insolvency is an important focus of the EBRD,
and, as in previous years, the EBRD’s Office of
the General Counsel has analysed insolvency
within the context of its survey of commercial law
extensiveness and effectiveness, presented in the
annual Transition Report since 1996. For an
explanation of EBRD survey practice, see J. Taylor
and F. April, “Fostering Investment Law in
Transitional Economies: A Case for Refocusing
Institutional Reform”, 4 Parker School Journal of
East European Law (1997), p.1.
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applying enforcement measures against market
participants acting in bad faith, but avoiding
violations of the present legislative framework.
To boost investors’ confidence, the FCSM
has initiated a State Programme for Protection
of the Rights of Investors. The Programme
aims to protect minority shareholders and
to improve corporate governance standards.
It encompasses 17 laws and regulations that
the FCSM will develop. Within the overall
framework of the Programme, the EBRD’s
Legal Transition Team provides technical
assistance in respect of amendments to the
Law on Joint Stock Companies in the following
general areas: general meetings, external
and internal auditors, board (including
independent directors) and executive
management. Such assistance will further
clarify the roles and obligations of Russian
directors and management towards the
protection of shareholders’ rights.
Czech Republic: reform of securities
regulation and strengthening minority
shareholder rights
The EBRD is currently undertaking a legal
technical assistance project to provide
support to the Czech Republic in establishing
a securities commission (the Czech SEC)
for the supervision and regulation of the Czech
capital markets. One of the primary objectives
of this project, funded by EU Phare,
is to provide assistance in institutionalising
a regulatory authority which will enable
the Czech capital markets to function in
an efficient, fair and transparent manner,
thus increasing the level of confidence
of the investor community.
More specifically, this project is designed
to achieve the following:
■ the development of regulations and
procedures for the proper functioning of
the Czech SEC;
■ thedevelopmentof regulations and
procedures (e.g., licences and licensing
procedures) for use by the Czech SEC in
order to ensure fairness, transparency,
efficiency and consistency in the exercise
of its powers;
■ the development of an appropriate
organisational and management structure
as well as operating systems and
procedures for the Czech SEC; and
■ training for commissioners and other Czech
SEC staff on matters related to the
functioning of the Czech SEC.
It is intended that the project will contribute
to the establishment of a functioning regulatory
authority, which in turn will support the
development of the Czech capital markets
into an increasingly important source of long-
term finance for private sector companies.
As such, the project will have a significant
impact on raising the standards of corporate
governance in the Czech Republic by
improving the transparency of Czech capital
markets and ensuring that Czech companies
are subject to rigorous oversight by the SEC.
Improving corporate governance in equityand debt transactions
The EBRD seeks to address corporate
governance issues directly in the context of
its financial transactions.
Equity investments
As an equity investor, the EBRD is
concerned that it obtains comprehensive,
reliable information about the affairs of its
investee companies. Therefore, the Bank
insists that the financial statements
of its investee companies are prepared
in accordance with International Accounting
Standards or other accounting standards
of broad recognition, and that financial
statements are audited by independent
auditors acceptable to the EBRD.
The EBRD is also concerned about the
integrity and transparency of the affairs
of its investee companies. Accordingly, it
conducts an integrity due diligence prior
to making an investment, and its transaction
documents are designed to ensure
that investee companies are and remain
in compliance with applicable laws.
The EBRD is also determined to prevent
fraud and corruption in its investee
companies, and it does not tolerate payment
of kickbacks and other illicit pay-offs.
In its equity investment operations, the
EBRD always takes minority shareholding
positions, and is therefore keen to promote
corporate governance arrangements protecting
the interests of minority shareholders.
In particular, the Bank insists on:
■ the integrity and reliability of
shareholder registries;
■ the absence of inappropriate transfer
pricing schemes;
■ the approval of major corporate
transactions and restructuring by a
qualified majority;
■ the exclusion of interested shareholders
from voting decisions regarding
matters on which they have a conflict
of interest; and
■ the arm’s-length procurement arrangements.
The EBRD seeks to reflect these principles
in charters of its investee companies, for
example, or in shareholder agreements to
which the Bank is a party.
The EBRD also aims to improve corporate
governance standards in its investee
companies by nominating, as members of
the boards of these companies, individuals
experienced in good corporate governance.
Debt investments
As a lender, the EBRD seeks to implement
principles of good corporate governance
through standard provisions in its loan
agreements (representations, warranties and
covenants). Specifically, under the terms of
the loan agreement, the borrower represents
and warrants to the Bank that:
■ the financial statements (balance sheet
and income statements) are prepared in
accordance with International Accounting
Standards or another set of broadly
recognised accounting principles;
■ the financial statements have been audited
by independent auditors acceptable to
the EBRD;
■ the financial statements present the true
and fair view of the borrower’s financial
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position, and include all material
contingencies and financial commitments;
■ the borrower is in compliance with all
applicable laws, including environmental,
health and safety laws, has filed all tax
returns, and has paid all required
government charges; and
■ neither the borrower nor any of its
officers, directors, employees, agents or
representatives has paid, promised
or offered to pay, or authorised payment
of, any commission, bribe, pay-off or
kickback related to the project.
Moreover, the borrower covenants to the
EBRD that it will:
■ maintain its corporate existence and
will conduct its business in accordance
with all applicable laws;
■ conduct its business with due regard to
the environment, health and safety;
■ maintain its accounts in accordance
with the agreed accounting standards,
and will maintain auditors acceptable
to the EBRD;
■ maintain all governmental approvals
required for its business;
■ conduct all its dealings on ordinary
commercial terms, and on the basis of
arm’s-length arrangements, and will
not enter into transactions whereby
the borrower would pay more than the
commercial price for any purchase or
would receive less than the full commercial
price (subject to normal trade discounts)
for its products or services;
■ not enter into any partnership, profit-
sharing or royalty agreement or other
arrangements whereby the borrower’s
income or profit is shared with another
person without the EBRD’s consent; and
■ not sell substantially all its assets,
merge with another entity or carry out a
reorganisation without the EBRD’s consent.
Improving corporate governance in work-outs
In work-outs, the EBRD seeks to promote
good corporate governance by insisting on
fair and equitable treatment of all financial
stakeholders. Where there is no prospect
of continued financial viability of a borrower
or investee company, the EBRD promotes
the orderly liquidation and fair distribution
of the liquidation proceeds in accordance
with applicable law.
Conclusion: next steps
The EBRD is committed to continuing and
reinforcing its promotion of good corporate
governance in its countries of operations.
As in the past, it will emphasise the importance
of good corporate governance in its legal
reform projects and other investment climate
work with the governments of its countries
of operations, and through its role as a
prominent investor and lender.
The EBRD has recently started work on
the development of a checklist to aid its
lawyers and bankers in the systematic
evaluation of the governance practices
of the Bank’s countries of operations and
potential investee companies. In future,
this checklist may be supported by model
charter provisions, which will serve as a
benchmark for its bankers and lawyers in
their work with prospective EBRD clients.
In addition, the EBRD will continue to
participate in international initiatives in the
area of corporate governance, such as the
Global Corporate Governance Forum recently
initiated through agreement between the
OECD and the World Bank.
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* In connection with the preparation of this article,
the author gratefully acknowledges the assistance
of Douglas Arner, Sir John Lubbock Fund Fellow
in International Capital Markets Law, Centre
for Commercial Law Studies, Queen Mary and
Westfield College, University of London.
Norbert Seiler
Deputy General Counsel
Office of the General Counsel
European Bank for Reconstruction and
Development
One Exchange Square
London EC2A 2JN
UK
Tel: +44 171 338 6143
Fax: +44 171 338 6150
E-mail: [email protected]
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 31
32
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Anita Ramasastry, Assistant Professor of Law, University of Washington
Stefka Slavova, Doctoral Candidate, London School of Economics, andDavid Bernstein, Chief Counsel, European Bank for Reconstruction and Development*
Market perceptions of corporategovernance – EBRD survey results
The focus on corporate governance within
firms relates in part to the separation of
ownership and control within a public
company. Shareholders as “owners” provide
the capital for the firm while management
and the board of directors control the firm
with respect to investment decisions.
Company law and legal rules have been
described as a means of holding management
accountable for its actions. Similarly,
company law also encourages means by
which shareholders can participate in
decision making with respect to the firm.
Good corporate governance is meant to
provide incentives for the board of directors
and management to act in the interest of
the company and its shareholders.
There has recently been an increasing
emphasis on developing international
principles of corporate governance that can
be implemented globally. The Organization
for Economic Co-operation and Development
(OECD) recently promulgated a set of
principles of corporate governance in an
attempt to foster international consensus
on this topic.1 The OECD Principles are
intended to assist member and non-member
governments in their efforts to evaluate and
improve the legal, institutional and regulatory
framework for corporate governance in their
countries, and to provide guidance and
suggestions for stock exchanges, investors,
corporations, and other parties that have a
role in the development of good corporate
governance. (For more on the OECD
Principles see the Legal Transition Events
section of this issue.)
Notwithstanding the OECD’s efforts, there
is no single or universal model of corporate
governance. Scholars have noted that the
United States, Germany and Japan all have
different structures for corporate governance
and offer equally useful models from which
transition economies might adapt their
own laws and regulations. Thus, the OECD
Principles are simply a framework which
sets forth basic principles.
Linking corporate governanceand external finance
There is a growing recognition of a correlation
between levels of external finance and the
existence of legal protections for investors
in different jurisdictions. Law, several
experts postulate, is a growing recognition
of determinant for the differing levels of
external finance found in various countries.
Economists Rafael La Porta, Florencio
Lopez-De-Silanes, Andrei Shleifer and
Robert Vishny have analysed how investor
protections, as well as the quality of their
enforcement, can have an impact on the
effectiveness of financial systems. Specifically,
these scholars have concluded that the nature
and effectiveness of various financial systems
may be linked, in part, to differences in
investor protections (against expropriation by
corporate insiders). In a study of 49 countries,
the authors concluded that countries with
poorer investor protections (measured by the
character of legal rules and the quality of
their enforcement) have narrower or smaller
capital markets.2 Thus, these economists
believe that there is a correlation between the
legal rules protecting investors and the level
of external finance that a country generates.3
The studies conducted by these economists
examine the substantive laws in a country,
but do not measure more subjective or
normative factors such as the perceptions
held by investors and their legal counsel or
the ability of such individuals to understand
the law as enacted. They do acknowledge,
however, that perceptions may have an effect
on the way markets develop, noting that “[it]
is possible that some broad underlying factor,
related to trust, influences the development
of all institutions in a country, including
capital markets.”4
The EBRD legal indicator survey
The EBRD’s Office of the General Counsel
(OGC) has, for several years, engaged in
research which attempts to measure market
perceptions of the extensiveness and
effectiveness of commercial and financial
laws in the Bank’s countries of operations.
This research, based on surveys, has focused
on the perceptions of lawyers and other
Russia’s default last summer and the Asian financial crisis have caused investors and academics
alike to focus on corporate governance and the potential impact that ineffective systems of governance
may have on shareholders in markets around the world. In central and eastern Europe and the
Commonwealth of Independent States (CIS), for example, investors are beginning to question
decisions made by management and to demand from management greater accountability and
transparency in the decision-making process.
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 32
experts. (By contrast, much recent economic
analysis of investor protections has focused
on a reading and scoring of substantive laws
and on measuring the effectiveness of a legal
system as judged by external rating agencies).
While surveys of perceptions of laws are no
proxy for a study of the trust which people have
in a legal system and its institutions, they do
provide data about a person’s comprehension
of, and views on, those laws. They may also
provide a resource for understanding how law
reform and legal frameworks affect external
finance. As the survey results reveal, countries
with sophisticated investor protections may
receive poor ratings when measured against
countries with more rudimentary laws, but
which have had less occasion to put them to
the test. In other words, a country with fewer
rules governing investor protection may be
perceived as having a more effective legal
environment than a country with more legal
protections but where there may be clear
evidence of enforcement problems.
For the past three years, one segment
of the OGC’s commercial law survey has
focused on company law and corporate
governance. The results of this survey,
analysed in this article, provide an indicator
of how legal practitioners and other experts
perceive corporate governance in the region
with respect to (i) the role shareholders
have in exercising control within joint-stock
companies and (ii) the legal rules which
govern or influence management behaviour
within joint-stock companies.
The questions in the survey centre on certain
aspects of corporate governance – specifically
the rights of shareholders (including minority
shareholders) and the responsibilities of
directors for management of the company.
The survey questions are based in large part
on the EBRD’s own corporate governance
guidelines, Sound Business Standards and
Corporate Practices, published in September
1997, as well on the OGC’s assessment
of good corporate governance practices.
We have also analysed answers to questions
which focus on the perceived effectiveness
of the legal system in general from an
investor’s perspective. The results presented
below are not based on a survey tailored
specifically to corporate governance. For
example, questions concerning capital markets
(included in a separate OGC survey on
financial markets) have not been analysed.
Some of the specific topics which the OGC
survey addressed include:
■ the formation of a joint-stock company
(time and expense);
■ the protections and rights of shareholders;
■ director and management accountability
(legislative duties and liabilities);
■ the role of accountants and auditors; and
■ the effectiveness of company law.
Much of the material that forms the basis
of this article is not readily verifiable and
reflects the subjective assessment of survey
respondents. Similarly, the information and
views provided by respondents were not
always consistent. Where there were large
discrepancies among respondents, recourse
to the EBRD’s in-house knowledge of the
conditions in that country was used to
arbitrate. Accordingly, while the purpose
of the survey was to reflect the perception
of lawyers concerning company law in the
region, care must be taken in reading and
interpreting the results.
General trends
Implementation problems appear as laws get used
The main challenge identified by the
survey is the pressing need to improve the
enforcement and implementation of company
laws. Many of the laws in the region provide
a sound theoretical basis for good corporate
governance. However, as courts, management
and shareholders put these models to the test
in each jurisdiction, the perceptions of
outside investors and lawyers may be less
positive than perceptions of less mature laws
which have not been tested regularly. In
1999, economic downturn has led a greater
number of shareholders in Russia, Hungary
and other jurisdictions to challenge the
actions of company management and boards
of directors. The Russian crisis, therefore,
may have created a climate where company
law and governance are being put to the test
and evaluated. Shareholder activism provides
an impetus for evaluating laws that may
previously have remained dormant.
Based on our review of the survey data,
respondents indicated that areas needing
further refinement and reform included:
■ the protection of shareholder rights through
the use of the proxy system for annual
meetings;
■ the creation of more transparent annual
meetings at which a shareholder can
exercise voting power;
■ the creation of clearer and more specific
standards for management liability and
accountability;
■ the implementation of shareholder rights
through co-operation with management
and court enforcement; and
■ the operation of share registries.
Newly enacted laws create positive perceptions
As discussed below, countries with recently
enacted laws tend to score higher in the year
1 OECD Principles of Corporate Governance,
SG/CG (99)(5) (OECD, Paris, April 1999).
2 See Rafael La Porta, Florencio Lopez-de-Silanes,
Andrei Shleifer and Robert Vishny, “Legal
Determinants of External Finance”, 52(3) Journal
of Finance 1131-1150 (July 1997), “Law and
Finance”, 106(6) Journal of Political Economy,
p.1113 (1998).
3 The OECD has similarly recognised this correlation:
“If countries are to reap the full benefits of the global
capital markets and if they are to attract long-term
‘patient’ capital, corporate governance arrangements
must be credible and well understood across
borders.” OECD Principles of Corporate Governance,
SG/CG(99)(5), p.3 (OECD, Paris, April 1999).
4 See note 2 above, p.1150. See also Kathryn
Hendley, Barry W. Ickes, Peter Murrell, and Randi
Ryterman, “Observations on the Use of Law by
Russian Enterprises”, 13(1) Post Soviet Affairs
19-41 (1997), which notes that Russian managers’
understanding of commercial law does affect their
use of legal institutions to solve economic problems.
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following the legislative changes. Kazakhstan
enacted a law in July 1998 that replicates
many provisions of the Delaware Corporations
Law. The Kazakh law is comprehensive and
with considerable protections for minority
shareholders.5 The enactment of this new
legislation has given Kazakhstan a higher
overall score for 1999 as compared with
significantly lower scores in 1997 and 1998.
Additionally, Kazakhstan received a high
score for the effectiveness component
of the company law survey, which reflects
respondents’ perceptions of the enforcement
of Kazakh company law and general laws
relating to investment.
Russia and Uzbekistan also received higher
scores in 1997 after new company legislation
had been enacted in 1996. Since then,
however, their scores have dropped
significantly. This result seems to reflect
evolving perceptions of the law once it has
been implemented. Legislation that appears
comprehensive and robust as enacted, may
be perceived as less effective and also less
extensive once implemented. By contrast,
countries that have seemingly comprehensive
laws on their books may receive higher
scores if they have fewer public companies
and hence fewer occasions to test the
effectiveness of the company law legislation.
That Moldova received a high score in
1998 may reflect its enactment of new
legislation in 1997. In 1999, however,
Moldova’s ratings dropped significantly,
possibly because problems had been
identified with the execution of the law.6
Perceptions change over time
As mentioned above, one of the most interesting
trends we identified is that respondents
seem to rank countries with comprehensive
company laws lower when the law has been
in place for some time and problems may have
arisen with enforcement and implementation
of shareholder rights. For example, the
scores of many of the countries listed as
having moderate corporate governance
protections, Bulgaria, Poland and Romania
(in addition to Russia) have declined
recently. This may reflect, to some extent,
frustrations experienced by foreign investors
when enforcing their rights.7
Similarly, the Czech Republic has received
lower scores despite having comprehensive
company and securities laws – possibly
because of conflicts of interests arising from
high levels of indirect bank ownership of
many companies, leading banks to act
simultaneously as investors and creditors.8
Lack of understanding of directors’ duties
The standard duty of care of corporate
directors can generally be considered
to consist of two duties: to monitor and to
make reasonable decisions.9 These duties
are found in a variety of laws and are not,
therefore, readily ascertainable upon a
reading of the joint-stock company law alone.
In many jurisdictions, respondents were
unable to reach a consensus on the level of
responsibility (if any) held by management
and directors with respect to their actions
on behalf of the company. When asked if
directors had any duties with respect to the
company and its shareholders, respondents
often provided conflicting answers for the
same jurisdiction.
For example, the Bulgarian Law on Commerce
does not contain any distinct provisions that
elaborate the legal standard of care to be
followed by directors and management of a
joint-stock company. Article 240(2) provides
that members of the management board and
supervisory board are jointly liable for any
damages they may cause. A member of the
board will not be held liable if the court finds
that the board member has no fault that can
be linked to the damage. Board members,
however, must deposit security for potential
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PolandBelarus
Ukraine
Romania
Kazakhstan
Estonia
Latvia
Lithuania
Moldova
Bulgaria
ArmeniaGeorgia
Azerbaijan
HungarySlovenia
CroatiaBosnia and
Herzegovina
Albania
CzechRepublic
UzbekistanFYR Macedonia
Slovak Republic
Russia
Kyrgyzstan
Reasonably comprehensive (3)Moderate (7)Limited (10)Ineffective (4)
TajikistanTurkmenistan
Perceptions of corporate governance†
† Insufficient survey responses were received from Tajikistan and Turkmenistan.
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 34
liability in an amount specified by the general
meeting of shareholders. The minimum is
their salary for a three-month period.
In the Czech Republic, members of the board
of directors and supervisory board are obliged
to perform their duties with due care and
to maintain the confidentiality of information
and facts (for which disclosure to third
parties would cause the corporation to suffer
damage). However, Section 66 of the Czech
Commercial Code states that the relationship
between a corporation and its members is
governed by rules of contract so it is possible
that the board members’ duties will be
different from those laid out in legislation.
Countries with low corporate governance
rankings often have no directors’ duties set
forth in company legislation. Ukraine, for
example, has no clearly articulated duties
in its company law (which dates from 1991).
Shareholder registries are increasingly prevalent
As a larger number of jurisdictions have
functioning stock exchanges, more jurisdictions
have established centralised or independent
depositories that act as registration points
and clearing and settlement agents for
securities traded on those stock exchanges.
Countries such as Bulgaria, Croatia, the
Czech Republic, Estonia, Latvia, FYR
Macedonia, Romania, Slovenia and Russia
all have some form of securities depository
and registration system for the sale and
transfer of share ownership; Romania’s
registration system is relatively new. Survey
results reveal, however, that implementation
could be improved. In some jurisdictions
respondents were unclear as to whether an
independent share registry existed.
Country survey results
Robust protections
Countries in this category are perceived as
having comprehensive protections that are
implemented in a robust manner. Courts and
regulators actively enforce these protections.
Legislations provides clear, broad protections
for minority shareholders, establishes strict
duties and liabilities for directors, and
creates necessary implementing institutions
such as shareholder registries. None of the
countries surveyed were perceived as
providing this level of robust corporate
governance protections.
Reasonably comprehensive protections
Countries in this category are perceived as
having laws providing minority shareholders
with comprehensive protections, including
the ability to elect directors by cumulative
voting, to solicit proxies from other
shareholders and to nominate candidates
for the board of directors. The law is
perceived as creating duties or liabilities
for directors that are clear and enforceable.
It also provides minority shareholders with
adequate protections in the event of the
acquisition by a third party of less than all
of the shares of a widely-held joint-stock
company. Respondents often indicated that
shareholder registries exist and function
in the jurisdictions and are often run
by independent third parties. Countries
in this category may need to improve
the implementation of their laws in order
to make the system function effectively.
In a few countries perceived as having
comprehensive systems, the law has not
been tested in practice due to the small
number of joint-stock companies or relative
newness of legislative reforms.
Moderate protections
Countries in this category have basic
protections for minority shareholders
including pre-emptive rights, majority voting
requirements, the ability to solicit proxies
and to propose shareholder resolutions at
the annual meeting. Areas where refinement
or improvement may be needed include
the elaboration of director’s duties and
responsibilities, the creation of independent
share registries and the refinement of
minority shareholder rights (for example,
the introduction of cumulative voting).
Implementation still lags behind the creation
of substantive law. Some countries that were
originally in the comprehensive category
have fallen into the moderate category
because poor enforcement has created
negative perceptions of investor protections
that appeared comprehensive on paper.
Limited protections
Countries in this category either have weak
substantive company laws or laws that
are perceived as weak because of problems
with enforcement and implementation.
Consequently, some of the countries in this
category may have laws that have adequate
substantive provisions but which have been
rendered ineffective because they are not
enforced. Several countries in this category
have enacted fairly major company law
reforms in the early to mid-1990s, but are
perceived as having poor laws in practice.
Alternatively, these jurisdictions are
5 See Curtis B. Masters & Azamat A. Kuatbekov,
“Kazakhstan’s New Joint Stock Company Law”,
BNA Eastern European Reporter, 127-131 (March
1999). For a general discussion of perceptions of
the Kazakhstan market and how legal reform
efforts have influenced perceptions, see “Eastern
Europe’s New Dawn Kazakhstan -- From Little
Acorns” Euromoney (10 April 1999).
6 1999 Investment Climate Statement on Moldova
(2 July 1999), prepared by the US & Foreign
Commercial Service and US Department of State
(www.bisnis.doc.gov/bisnis/country/wstnis.htm#
Moldova).
7 See, for example, “Deza Victor Skirts Buyout:
‘If National Power can do it, so can I,’ says Agrofert
Head Hana Lesenarova”, Prague Business Journal
Publishing Inc (7 June 1999); “World Bank Report
Urges Czechs To Limit Abuse Of Capital Markets”,
Dow Jones International News (17 November
1998); John Reed, “No Comfort Zone: Bulgaria
Makes an Appearance on Portfolio Managers’
Radar Screens, but Poor Liquidity and Shifting
Rules Narrow the Investment Band”, Central
European Economic Review (February 1998).
8 See John Nellis, “Time to Rethink Privatization
in Transition Economies” 36(2), Finance &
Development International (International Monetary
Fund, June 1999); Eva Thiel, “The Development
of Securities Markets in Transition Economies:
Policy Issues and Country Experiences”,
Financial Market Trends (OECD, June 1998).
9 See Melvin Eisenberg, "The Duty of Care of
Corporate Directors and Officers", 51 University
of Pittsburgh Law Review 948, 951, 956 (1990).
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perceived as having limited company laws
with minimal protections for shareholders
and few clear provisions dealing with
the responsibilities of directors. The company
law may include pre-emptive rights and
majority voting requirements, but respondents
believe additional protections are needed
(for example, the ability to participate
at annual meetings, solicit proxies and
propose shareholder resolutions). Directors
and management are not perceived as
accountable to shareholders for their actions.
Enforcement and implementation are a major
issue for these countries. As with some
countries in the “moderate” category,
countries with limited protections may have
complex laws that have been difficult for
lawyers either to understand fully or to
implement effectively.
Ineffective protections
These countries have only rudimentary
company laws that do not address corporate
governance as a specific topic. Minority
shareholders are perceived not to have many
of the basic protections, including majority-
voting requirements and the right to solicit
proxies or to propose resolutions for annual
meetings. Directors are perceived as having
no specific accountability for their actions.
Law is perceived as needing large-scale
refinement and amendment. This may be,
in part, due to lack of a strong equity market
and the smaller number of joint-stock
companies in these jurisdictions.
Perceptions of individual countries
An analysis of the 1999 results shows
that of the countries surveyed, the results
with respect to some of the “comprehensive”
and “limited” countries correspond to
a plain reading of the legislation in these
jurisdictions. For example, the Hungarian
joint-stock company law is considered
by many commentators as a good example
of a law that protects minority shareholders
and encourages effective management
of a company’s resources through self-
enforcing governance provisions. By contrast,
countries such as Belarus and Bosnia
and Herzegovina have more rudimentary
company laws needing substantive refinement
and amendment.
Kazakhstan was perceived as having
comprehensive protections in 1999, which
probably reflects the adoption of a new joint-
stock company law in July 1998.
(Kazakhstan’s lower score in 1998 may be
due to the fact that the new law became
effective shortly after respondents received
the 1998 questionnaire.)
The new Kazakh law has certain safeguards
against conflicts of interest between
management or majority shareholders and
the company. For example, in an effort to
promote greater transparency, the law requires
that interested parties (officials of the company
or shareholders with at least 5 per cent of
voting shares) must be fully disclosed and
approved by a majority of the disinterested
members of the board. Additionally, certain
major transactions must be reviewed by
the shareholders.
The new Kazakh law also includes certain
provisions for minority shareholder
protections. Any shareholder with at least
5 per cent of a company’s voting shares may:
■ convene an extraordinary general meeting;
■ add items to the agenda for a general meeting;
■ nominate candidates for the company boards;
■ receive a list of shareholders; and
■ have a representative on the company’s
liquidation commission.
These rights did not exist under the previous
law or were limited to holders of 20 per cent
or more of voting shares.
One of the major drawbacks of the new law
is the requirement that additional shares
should only be issued pursuant to a court
order. This provision allows the state, with
court consent, to force a company to issue
new shares to new shareholders, the proceeds
of which can be used to pay a company’s
back taxes and other overdue payments to
the government. This provision creates the
opportunity for a large dilution of shareholder
interests in a company.
Hungary has received consistently high scores
over the three years that OGC has conducted
the company law survey. Hungary’s law appears
to retain stability and robust protections both
on paper and in practice. Interestingly,
minority shareholders in Hungary have begun
to challenge the actions of directors and
management. For example, in the spring of
1999, minority shareholders at two annual
meetings were able to force out several board
members.10 Increased shareholder activism,
however, has not altered the perceptions of
respondents as to the effectiveness of company
law. Additionally, Hungary has amended its
company and securities laws in 1999,
expanding some shareholder protections and
narrowing others. For example, shareholders
could previously call a special meeting or
include an agenda item at the general
meeting. Now, however, shareholders must
seek court approval in order to exercise these
powers. In contrast, the amendments specify
that an offer to purchase 33 per cent or more
of the shares of a publicly held company
must be made to all shareholders of that
company. This provision protects minority
shareholders from the potentially overreaching
behaviour of a controlling shareholder.
Slovenia also received a high overall rating
from respondents. This ranking is somewhat
consistent with the EU’s recent screening
of Slovenia’s corporate law in the light of
harmonisation with EU standards. The main
deficiency noted by the Commission was
a discriminatory provision in Slovene law,
which states that only Slovene citizens
may serve as directors of an enterprise.
The Slovene government has stated that it
will lift this restriction.11 However, Slovenia’s
high rating could also reflect the fact that
the law has not been truly tested due to the
lack of foreign investors in the market.12
For the lawyers who responded, the law may
be seen as adequate to protect the interest
of local investors and shareholders.
Of more interest are the countries considered
to have moderate or limited corporate
governance protections. Some of the countries
with moderate protections may, in fact, have
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quite comprehensive company laws on their
books. The score discrepancies may, to some
extent, be due to respondents having greater
expectations for jurisdictions with active
equity markets and a larger number of joint-
stock companies (for example, Bulgaria,
Estonia and Poland). When provisions are
tested in practice as well as in court, lawyers
appear to become more critical of the way the
law actually works in these jurisdictions.
Poland has often been cited as a country
with a good corporate governance regime.
Poland is a “fast-track” candidate for EU
accession and its company law has been
scrutinised and evaluated as part of the
accession process. Yet, surprisingly, Poland’s
score dropped in 1999. Minority shareholders
in Poland have become increasingly active.
For example, management at Elektrim,
a joint-stock company, stepped down amid
protest from minority shareholders after
management revealed the existence of a 1996
agreement to sell shares of a subsidiary to
another company for a nominal price. However,
unlike Hungary, this increased activism
appears to have created a negative rather
than positive perception from respondents.
In early 1999, Poland published a new draft
Law on Companies which includes new
provisions for mergers and acquisitions and
also de-mergers and splits. While the new
legislation does not directly impede or alter
existing shareholder rights or protections,
the fact that changes have been proposed
(and have been under consideration since
the fall of 1998) may have altered perceptions
of the existing company law.
FYR Macedonia and Moldova, both of
which rank relatively high, have enacted
new company legislation within the past few
years and have created new systems for the
registration of shares and share transfers.
At the same time, both countries have often
been cited for ineffective enforcement of
commercial legislation. Nonetheless, they
may score highly because with fewer joint-
stock companies and inactive capital
markets, the legislation has not been utilised
or “tested” in practice.13
Countries perceived to have limited protections,
such as Estonia or the Czech Republic, may
have fared poorly because respondents have
a pessimistic view of the way in which the
law functions. The Czech and Slovak
company laws, for example, are quite similar
in form and substance – yet Slovakia scores
higher. This may simply reflect the fact that
there is a greater volume of transactional and
corporate legal activity in the Czech
Republic, giving lawyers an opportunity to
scrutinise the Czech legislation more closely.14
The Czech capital market is one of the oldest
and most active capital markets in the EBRD’s
countries of operations. The problems that
have recently been highlighted may be a
natural product of increased activity in this
market. Czech legislation has been criticised
for having loopholes or ambiguities with
respect to when investors are required to
make an offer to purchase all outstanding
shares in the event of a take-over. In certain
circumstances, shareholders have appeared
to act in concert to acquire majority
shareholdings without triggering a requirement
that they buy out minority shareholders.
This is partly due to the fact that none of
10 See “Hungary’s Stockmarket: Getting Hostile”,
The Economist, Vol. 351, Issue 8120 (22 May
1999); “Hungary: Minors Strike Minority
Shareholders Are Taking Sluggish Hungarian
Companies to Task”, Business Eastern Europe
(24 May 1999).
11 See EU/Slovenia: “Monte Stands Firm on Need
for Follow-through of New Legislation”, Information
Access Company (16 May 1998) ISSN 1021-
4267. (Article discusses Slovenia’s agreement
to harmonise its company law). See also
Slovenia: 1999 Country Commercial Guide
(Fiscal Year 1999), (Central and Eastern
European Business Information & Center,
United States Department of Commerce),
www.mac.doc.gov/eebic/countryr/slovenia.htm.
12 “Transition Assessments for Slovenia”, EBRD
Transition Report 1998, p.190, noting that
foreign direct investment has been discouraged
by excluding foreigners from the privatisation
process and by the gradual introduction of capital
account restrictions since 1995. Foreign direct
investment inflows increased from 1.0 per cent
of GDP in 1996 to 1.8 per cent in 1997, but
early figures for 1998 indicate a reversal of this
upward trend.
13 For example, in 1998, there were apparently no
investment disputes in Slovak courts.
See Slovakia: 1999 Country Commercial Guide
(Fiscal Year 1999 – prepared July 1998), (United
States Foreign Commercial Service and United
States Department of State), www.mac.doc.gov/
eebic/countryr/slovakr/ccg/index.htm.
14 This view was echoed by the European
Commission, which noted last summer that
while the Czech Republic meets the European
Union’s economic criteria for accession, it needs
to improve its corporate governance. See
“EU Commission Report to Confirm Czech’s
Worsening Reputation”, Czech News Agency,
World Reporter (13 September 1999).
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Central Asia
CIS
South Eastern Europe
Central Europe/Baltics
0
10
20
30
40
50
NeverRarelySometimesFrequentlyAlmost always
% of respondents by geographical group
Shareholder activism – Use of lawsuits by minority shareholders
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the acquiring shareholders have individually
owned more than 50 per cent of the target
company’s stock. By avoiding the 50-per
cent ownership threshold, these investors
have avoided having to buy out minority
shareholders. Recently, the Czech SEC stated
that it did not have the legal authority to rule
in cases of problematic shareholder buyouts,
leaving these cases to be heard by the courts.
Estonia may also be perceived as having
weak protections due to its seemingly lower
level of minority shareholder protections.
Pre-emptive rights, for example, are not
included in Estonian legislation. Nonetheless,
the Estonian Stock Exchange has attempted
to address some of these deficiencies by
placing requirements on companies in the
listing and delisting process.
Countries that received an ineffective rating
have done little to reform their company laws
and have fewer companies due to lack
of outside investment. The exception in this
category is Azerbaijan, which has seen an
increase in foreign direct investment related to
the oil industry. However, changes to the Azeri
law and changes in practitioners’ perceptions
of company law may be reflected in future
surveys in the light of the enactment of a new
Azeri law on limited liability companies that
came into force in April of 1999. This was
before the mailing of the questionnaire, but
perhaps too soon for the law’s effect to
be appreciated by the respondents.
Shareholder activism
One of the survey questions asked respondents
whether minority shareholders have brought
lawsuits against companies or directors in
order to protect or enforce their ownership
rights. Responses reveal not only how
shareholders feel about exercising their rights
but also something about how they view the
courts’ work in protecting these rights.
In many instances (especially publicised
cases), minority shareholders that have
litigated high-profile cases in various countries
in central and eastern Europe and the former
Soviet Union have tended to be larger
investors that have disputes with management
who exercise control of an enterprise.
Respondents were given five options: never,
rarely, sometimes, frequently or almost
always. Those who answered “sometimes”
felt that shareholders would bring litigation
more than 50 per cent of the time. Those who
answered “rarely” felt shareholders would
go to court only about 25 per cent of the
time. Results comparing responses across
different geographic groupings are shown
in the bar graph on the previous page.
Interestingly, the central European and
Baltic respondents noted that shareholder
activism (in the form of litigation) occurred
more frequently than respondents in the CIS,
Balkans or in Central Asia. Fifty-eight per
cent of respondents in central Europe and
the Baltics noted that minority shareholders
were more likely than not to bring actions
against a company or its directors (that is,
58 per cent felt that minority shareholders
would bring lawsuits sometimes, frequently
or almost always). In the Balkans or southern
Europe, respondents were almost as
optimistic: 45 per cent indicated that
minority shareholders were more likely than
not to bring lawsuits. In contrast, Central
38
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Central Asia
CIS
South Eastern Europe
Central Europe/Baltics
0
10
20
30
40
50
60
NeverRarelySometimesFrequentlyAlmost always
% of respondents by geographic group
% of respondents overall
Never 18%
Rarely 20%
Almost always 1%
Frequently 14%
Sometimes 47%
Perceived court fairness – Do courts side with shareholders rather than management?
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 38
Asian respondents were less positive and
only 33 per cent of respondents believed that
minority shareholders would litigate. The
figure was even lower in the CIS, with only 31
per cent of respondents answering positively.
The view of CIS respondents is perhaps the
most interesting because there has been a
great deal of publicity about a number of
high-profile lawsuits that have been brought
in Russia by foreign investors with minority
stakes in Russian enterprises. Despite the
publicity in Russia, respondents in other
CIS countries still believe that on average,
lawsuits are not perceived as an effective tool
for investors seeking to enforce their rights.
Fairness in court enforcement
Respondents were also asked whether courts
tended to side with shareholders as opposed
to the company in legal disputes. As the
pie chart shows, nearly half of all
the respondents (47 per cent responded
“sometimes”) felt that courts sided with
shareholders over management more than
half the time. More surprisingly, 62 per cent
of all respondents believed that courts were
more likely to side with shareholders in legal
disputes (adding together “almost always”,
“frequently” and “sometimes” responses). As
the bar graph shows, these results are
relatively consistent across the countries in
the region – for all the regional groupings
except Central Asia “sometimes” was the
most frequent response. However, it should
be noted that over one-third (38 per cent) of
all respondents did respond that courts
“rarely” or “never” sided with shareholders,
revealing a significant continuing bias
in favour of management and powerful
commercial interests. Nonetheless, respondents
(who are likely to represent minority
shareholders and foreign investors) do feel
that shareholders are more likely than not
to get a fair hearing if they try to defend
their rights in court.
At first glance, these results may seem
counter-intuitive given the generally negative
view of courts in the region. Criticism of the
courts and judges ranges from allegations
of corruption or bias towards the government
or powerful commercial interests, to a general
lack of understanding of newer commercial
laws and complex commercial transactions.
However, the survey results reveal that
respondents do feel that the court system
can provide an effective means of redress
and protection for shareholders’ rights.
Conclusion
An interesting feature of the OGC corporate
governance survey is the observation that
the perception of the extensiveness and
effectiveness of a country’s corporate
governance seems to follow a relatively
consistent cycle. There is an initial lag from
the adoption of a new law or amendment of
existing legislation to an improved perception
of corporate governance protections. Once
the change in law is better understood and
perhaps assessed (on paper) by leading legal
practitioners inside and outside the country,
this lag will be overcome and the survey
results will become more positive. However,
as the shareholder rights and director
obligations contained in the company laws
in the region are actually put into practice,
possibly through the growth of shareholder
activism, the perception of corporate
governance can turn decidedly negative.
There may be some steps that countries
can take to shorten this cycle or, better yet,
use the cycle to continually improve
corporate governance protections. Initially,
the lag between the adoption of improved
shareholder protections and the positive
perception of these changes could be
shortened by more effective publicity,
closer involvement of affected groups in
the legislative process, and increased
attention to training for lawyers, judges
and regulators. In addition, problems in
the enforcement of these shareholder rights
and management obligations, highlighted
by their use and increasing shareholder
activism, may lead governments to make
refinements and improvements more quickly
in both company law and the necessary
implementing institutions.
As with past OGC surveys, the results of
the corporate governance survey reveal
a clear gap in the effective implementation
of minority shareholder protections and
management obligations. If the countries
in the region are to improve corporate
governance and attract both more domestic
and foreign investment, they will need to
fill this effectiveness gap. This will require
additional financial resources both to
reform laws and strengthen enforcement
institutions such as the courts and national
securities commission. More importantly,
governments will have to muster the political
will to overcome the opposition of those
entrenched commercial interests which
benefit from the effectiveness gap.
* Anita Ramasastry
Assistant Professor of Law
University of Washington, School of Law
1100 NE Campus Parkway
Seattle, WA 98105
USA
Tel: +1 206 616 8441
Fax: +1 206 616 3427
E-mail: [email protected]
Stefka Slavova
Doctoral Candidate
Department of Economics
London School of Economics
London WC2A 2AE
UK
Tel: +44 171 405 7686 ext. 2139
Fax: +44 171 831 1840
E-mail: [email protected]
David Bernstein
Chief Counsel
Office of the General Counsel
European Bank for Reconstruction
and Development
One Exchange Square
London EC2A 2JN
UK
Tel: +44 171 338 6820
Fax: +44 171 338 6150
E-mail: [email protected]
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Law and corporategovernance in practice: BP Amoco p.l.c.
For a corporation such as BP Amoco, the extent to which its governance
depends on law in all its forms – statute, subordinate legislation, rules of
regulatory bodies, non-legal codes enforced by the authorities, judge-made
law and contract – is not obvious from a cursory examination. This article
attempts to throw some light on the role law plays in the governance of
BP Amoco so that its significance can be better appreciated.
Rodney L. Insall, Vice President Corporate Governance, Company Secretary’s Office, BP Amoco p.l.c.*
BP Amoco p.l.c.
BP Amoco is one of the world’s top three
petroleum and petrochemical businesses on
the basis of market capitalisation, with wide
operational and geographic scope. It has
well-established operations in Europe, North
and South America, Australasia, Asia, and
parts of Africa. In mid-July 1999, its market
capitalisation was around US$ 180 billion.
The current composition of BP Amoco’s
business is the result of some major sales,
mergers and acquisitions over the past
decade. It incorporates the oil businesses of
a number of companies including The British
Petroleum Company p.l.c., Standard Oil
Company of Ohio Inc. (Sohio), Britoil p.l.c.
and Amoco Corporation Inc. BP Amoco plans
to purchase ARCO, another substantial oil
company, by the end of 1999.
BP Amoco has approximately 515,000
registered ordinary shareholders who are
entitled to one vote for each share.1 However,
many individuals who are beneficially
interested in BP Amoco shares hold their
interests through various kinds of financial
intermediary. A notable example is the group
of 330,000 holders of American Depositary
Shares, whose interest in BP Amoco shares
is held on trust for them by Morgan
Guarantee Trust Company of New York.
Institutional shareholders, which invest in
shares on behalf of their customers, hold
around 90 per cent of BP Amoco’s issued
shares. Individuals hold the remaining
10 per cent. No shareholder or intermediary
controls more than 4 per cent of the voting
rights on ordinary shares. The shares
are listed primarily on the London Stock
Exchange but there are also secondary
listings on other major stock exchanges such
as the New York Stock Exchange.
The shareholders of BP Amoco have elected
a board comprising 21 directors, of whom
14 are outside directors, that is, non-executive
directors. The other seven directors are
employees of the company. The board
appoints a chairman and deputy chairman,
both of whom are non-executives. The board
also appoints a chief executive officer (CEO)
to head the organisation. Currently, in
addition to a head office, the activity of the
company is divided into about 140 business
units. The number of employees at the end
of 1998 was just under 100,000.
The origins of BP Amoco go back to 1901
when a single entrepreneur, William D’Arcy,
acquired the right to explore for oil in Persia
(as Iran was then called). D’Arcy used his
own money and set up a small organisation
consisting of himself, a few close associates
and a few employees. The objective of this
organisation was to start a business and,
after eight years of difficult trials, the
organisation found sufficient quantities
of oil to make investment in production and
transport facilities worthwhile. During the
first phase, the business activities of D’Arcy’s
organisation were simple and required no
legal vehicle, such as a company. This history
illustrates the important distinctions between
an organisation (a group of people associated
for a common purpose), the purpose of the
organisation (in this case the purpose was
business) and the legal vehicle or form used
by the organisation (in this case it was
contracts between D’Arcy and a range of
other people).
The legal vehicle that the BP Amoco
organisation has used to arrange its activities
since 1909 is a company registered under
the English Companies Acts. Shareholders
hold shares in this English company. This
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company has served as the acquiring vehicle
for all the major transactions mentioned
above. In making references to the company’s
history, therefore, this article considers only
the activities of this English company and
does not take into account the activities
of other companies before they merged with
it or were acquired by it.
The company also owns subsidiaries in
many jurisdictions around the world and
generally owns all the shares in those
subsidiaries. BP Amoco subsidiaries
do not normally issue shares to the public.
The main reason for the creation of the
subsidiaries is to optimise the tax position
of the business. These subsidiaries do not
operate independently; in other words, they
do not serve as a means of organising the
activities of the company and their legally
required formal processes are kept to
a minimum.
Governance
In the context of an English registered
company, governance may be thought of as
the range of ways in which those who act on
behalf of the company are required to carry
out the company’s purpose, as established by
the shareholders. In other words, governance
covers the various ways of ensuring that
directors and employees run the company’s
business so as to benefit shareholders as
a whole. Governance therefore covers
mechanisms and systems that range from
statute law to the influence of the news media.
Governance is needed both to protect
shareholders and to protect other groups
affected by the corporation’s activities.
It protects shareholders by counteracting the
human tendencies of directors and employees
to put their own interests ahead of the
shareholders’ or to favour the interests of some
other party, such as the local community or a
customer, at the expense of the shareholders.
It protects minority shareholders against
actions of powerful shareholders that prejudice
the interests of the minority. Governance
protects other groups affected by the
company’s activities by resisting the tendency
of overzealous directors and employees to
enhance their or the shareholders’ interests
at the expense of the legitimate interests
of such groups. Shareholders are rightly
concerned about governance of the
corporations in which they participate but
other groups may have valid concerns too.
In an English registered company, it is laid
down as a matter of law that the right to
control the activities of a company, that
is to vote on resolutions at shareholder
meetings, belongs to the “members” of the
company. The members need not be the
suppliers of finance to a company though
in listed companies they usually are.
For example, the members may be customers,
as in a customer co-operative, or suppliers,
as in a supplier co-operative. In a company
limited by shares, the members are known
as shareholders and this is the form of
company usually selected when members
are the suppliers of finance to the company.
As a matter of English law, therefore,
only the members of the company acting
collectively are entitled to elect and dismiss
directors. Only members can require the
directors to account to them for their actions.
The members (or shareholders) may therefore
be said to be the holders of the control rights
in an English registered company. As such,
they are the only group that is legally entitled
to decide what the overall objective of the
company’s activities should be.
BP Amoco has been a business enterprise
since its inception as an oil exploration
venture in 1901, when D’Arcy invested his
own wealth in the search for oil. His objective
at that time was simply to obtain the
best possible return on his investment.
The shareholders of BP Amoco today have
inherited that objective and, although the
purpose of the company has varied over time
as the nature of the shareholders has varied,
there can be no doubt that current shareholders
see their shareholding in BP Amoco as an
investment in a business enterprise on which
they expect a competitive return.
Given that shareholders of BP Amoco have
adopted “business” as the purpose of their
investment, it is important to be precise
about the meaning of “business”. The precise
definition of business as understood in BP
Amoco is to maximise the long-term value
of the shareholder’s interest in the enterprise
by selling goods and services. A vital element
of this definition is the long-term character
of business. Unless the enterprise is to be
terminated and liquidated immediately, its
value will depend on its future performance.
Valuation of a business enterprise on the
basis that it will continue to operate requires
an assessment of the future prospects
of the business; hence the value of an
ongoing business inevitably requires a
long-term perspective.
The ways of ensuring that BP Amoco’s
directors and employees carry out the
purpose adopted by the shareholders operate
at all levels in the company’s organisation.
However, in this article it is intended to
discuss governance at the first two levels
in the company organisation, that is, the
shareholders and the board.
Shareholder processes
The means that shareholders can use to
require directors to pursue the corporate
purpose can be divided into collective and
individual actions.
Collective actions
One way in which BP Amoco shareholders
can ensure that the board carries out the
corporate purpose agreed by them is through
the use of their voting rights in properly
constituted collective decision-making
processes. For all English companies,
company law requires a properly constituted
shareholder meeting for shareholders to make
1 BP Amoco also has a small number of preference
shares outstanding and they are also entitled to
vote at general meetings.
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a valid collective decision. The law was
drafted with relatively small numbers of
shareholders in mind and, for companies
such as BP Amoco with large numbers of
shareholders, a meeting of all or a large
proportion of shareholders is physically
impossible. For such companies, shareholders
can only participate in collective decision-
making by submitting proxy votes, that is, in
effect by postal voting. With its shareholders
dispersed all over the world, BP Amoco has
recently amended its articles of association
to ensure that only procedural matters
can be voted on by the members present
at a shareholder meeting; all other matters
have to be decided by a formal poll of all
shareholders including the proxy votes
sent in by those not present.
Shareholders typically do not organise
shareholder meetings themselves; directors
organise such meetings on behalf of
shareholders. To guard against the likelihood
that directors will use their position to
frustrate the ability of shareholders to make
a decision that is contrary to directors’
wishes, the law has intervened to give
shareholders rights to call a meeting, to
circulate a proposed resolution or statement
to members and to insist that various matters
be put to a shareholder meeting before they
can take place. Such matters include:
■ alterations to the company’s constitutive
documents (known as the memorandum
and articles of association in English
companies) which include in very broad
terms a definition of the corporate purpose;
■ transactions in which the directors have
a conflict of interest;
■ issues of shares;
■ repurchases of shares;
■ major acquisitions and disposals of assets.
The machinery of the shareholder-board
relationship involves at some point the
following kinds of collective decisions by
shareholders:
a) A delegation of authority to the
board by the shareholders in the articles
of association.
Given shareholders’ powers to elect and
dismiss directors, in reality, directors derive
their powers to run the business from the
shareholders. Consistent with this, BP
Amoco’s articles of association contain a
delegation of authority from shareholders to
directors. For delegation to be most effective,
there should be a clear distinction between
the powers retained by the shareholders and
those delegated to the board. In English
companies, such a distinction usually exists.
English company law and the BP Amoco
articles of association state specifically the
limited but important powers that shareholders
retain. By implication, the rest of their powers
are delegated to the board. The law allows
shareholders to take back additional powers
if they wish and this clear, simple division
of powers has worked well in practice.
b) The general statement of the
corporate purpose in the memorandum
of association.
Due to the English courts’ unfortunate
application of the ultra vires concept to
companies, the statement of purpose in the
memorandum of association has become so
general that it scarcely serves its intended
purpose. In this respect, one could say that
English company law does not help good
governance. The response of business people
and investors has been to work round
these difficulties. Boards informally and
continually work out their own specific
understanding of the shareholders’ collective
view on the corporate purpose.
c) Specific directions to the board by
passing a special resolution (75 per cent
supermajority).
If shareholders are unhappy with the way in
which the board is running the corporation,
they can direct the board to do something
by passing a special resolution. Specific
directions by shareholders are very unusual
in the experience of English companies and
have not been used by BP Amoco shareholders
as a way to ensure that the company is being
governed properly. It is worth noting that,
through their collective decision-making,
shareholders can realistically deal with only a
very limited number of issues. It is necessary
for shareholders to delegate extensive authority
and discretion to the board of directors to
run the business on their behalf. English
statute law recognises this by suggesting
a supermajority (75 per cent) should be
required in a company’s articles of association
for any shareholder resolution to constitute
a binding direction to the board of directors.
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d) Appointment of an external auditor
and acceptance of the annual report
and accounts.
Reporting to shareholders on the performance
of the company is essential for shareholders
to be able to check whether directors
are achieving the corporate purpose.
The requirement for the board to provide true
and fair reports to shareholders is clearly
recognised in English company law, which
includes a detailed prescription of how
reporting should be done. In addition, the law
requires reports to be audited by external
auditors appointed by the shareholders.
The effective operation of the reporting system
depends on the availability of expert auditors:
an expert accounting profession able to
provide audit services has developed in the
UK to meet this need. This profession has
played an increasingly important role in the
development of accounting standards and the
implementation of new standards has resulted
in regular improvements in the quality of
reports to shareholders by English companies.
Although directors are not required to
submit their annual report and accounts to
shareholders for approval, it would be possible
for shareholders to pass a resolution rejecting
such a report as inadequate. However, this is
rare and has not occurred in BP Amoco.
e) The requirement that the remuneration
of directors be approved by shareholders.
In one sense, requiring shareholder approval
for directors’ remuneration2 is a specific
protection against the temptation for directors
to set their remuneration above the market
level. However, it can have greater
significance for governance of the company
if shareholders insist on the incorporation of
incentives in directors’ remuneration that
align the rewards of directors with the rewards
of shareholders. In the UK, shareholders’
views on whether to incorporate incentives
in the remuneration of directors are equivocal
(though not so for employees). Moreover,
the use of share-based incentives is contrary
to the spirit of English company law.
Consequently, BP Amoco does not at present
include incentives in the remuneration of
(non-executive) directors.
In addition, shareholders have the right
under English company law to remove
directors by passing an ordinary resolution
(simple majority) at a shareholder meeting.
Groups of BP Amoco shareholders can enter
into organised collective action outside a
formally constituted shareholder meeting,
for example, by meeting to discuss a specific
issue. However, if shareholders at such a
meeting agree to act together, then they face
quasi-legal restrictions on their collective
decisions and action. In the UK, if a group of
shareholders that collectively owns 30 per cent
or more of a company agrees to act together
in some way, they are required under
The City Code on Take-overs and Mergers
(the “Take-over Code”) to make a cash offer
for all the shares in the company. This Code
has no legal status but is recognised by the
courts as a system of regulation in which they
will not interfere. The sanctions for breaking
the Take-over Code include action by various
bodies that regulate the securities markets
and exclusion from the UK securities markets.
Individual actions
Another important way in which shareholders
can influence the governance of BP Amoco is
through their individual decisions to own BP
Amoco shares or not. Shareholders and
potential investors are constantly assessing
whether to buy, hold or sell shares based on
their own opinions of the performance of a
company and its prospects. Assuming a liquid
market in the shares of a company, their
aggregated individual judgements are reflected
in the market price for the shares. At any
given price, there will be those who feel that
the directors are running the business well
on their behalf and those who do not. Those
who do not can dispose of their shares. The
availability of this option naturally depends
on the existence of a fair and efficient market
in securities and such a market depends
partly on the existence of a body of well-
designed and enforced securities laws.
The daily turnover in BP Amoco’s shares is
between 10 and 20 million shares, which
means that it is relatively easy for small
quantities of BP Amoco shares to be bought
or sold without influencing the price.
If small shareholders in BP Amoco feel
that the company is not being run in their
interests, they have the option of selling
without cost to themselves.3 However, most
of BP Amoco’s shares are held by large,
investment institutions which hold such
large numbers that it would be impossible
for them to sell without depressing the price.
For them, this individual option to buy, sell
or hold is of marginal value.
If the aggregated judgements of shareholders
and potential investors in general is that
BP Amoco is not being run in their best
interests, then the price of the shares
will fall relative to alternative investment
opportunities. A falling share price is a
problem for directors if they need access
to capital; they will find it difficult to raise
finance through the issue of shares. A falling
share price will also lead to pressure on a
company from shareholders to buy back its
shares. If the share price languishes for long,
other boards and managements will become
interested in taking over a company’s
business because they believe they can
run it better. The threat of take-over is the
ultimate sanction that shareholders can turn
to if the board of BP Amoco is not giving
them what they want. Although take-overs
are costly and rarely used, the threat of a
take-over is an important component within
the system of ensuring that English listed
companies are well governed.
An active market for take-overs and
mergers requires a well-developed system
of securities laws and securities market
regulation. In the UK, take-overs are
2 This article distinguishes between remuneration
received for work as a director from remuneration
received for other work, such as the work of
an executive in the company under a contract
of employment.
3 In selling, a shareholder will, of course, incur
transactions costs but these are minor.
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regulated specifically by the Take-over Code
which, as explained above, is not law but
is enforced indirectly by the agencies that
regulate the UK securities markets. Given
the necessity for supermajority shareholder
approval of changes to a company’s
constitutive documents, it has been difficult
for the boards and managements of UK-listed
companies to adopt rules that would frustrate
take-overs (so-called “poison pills”). In any
case, there is little point in adopting such
rules because the Take-over Code specifically
forbids the board or management of an
offeree company taking any action that would
frustrate a take-over offer. BP Amoco has
never proposed amendments to its articles
of association that would have the effect of
frustrating a take-over offer and accepts the
threat of take-over as an important part of
ensuring that the company is well governed.
Equality and fairness
The governance of BP Amoco depends
fundamentally on the existence of general,
stable agreement among shareholders on the
corporate purpose and the way in which
shareholder wealth is to be distributed.
Without this, directors and employees would
be left without a clear and reliable guide on
how they are supposed to act. In a company
such as BP Amoco, where currently the
shares are widely dispersed and no
individual shareholder controls more than
4 per cent of the votes, it is easier to obtain
widespread support among shareholders for
the very general corporate purpose stated
above. Moreover, having one vote for each
share and thus making voting proportional to
the amount of investment gives shareholders
an incentive to view their shareholding as
an investment in a business enterprise.
In the past, this has not always been so.
At one stage, the UK government held a
majority of the shares in BP (as it then was)
and its objectives were not simply to
maximise the return on its investment. In
situations like this, the dominant shareholder
has the voting power to change the corporate
purpose against the wishes of the minority
and to alter the way in which shareholder
wealth is shared out. To guard against such
abuse, UK company law requires 75 per cent
supermajorities for many of the fundamental
collective shareholder decisions. In addition,
the law does give shareholder minorities legal
remedies against abuse by the majority.
Similarly, the Take-over Code is based
on the principle of equal treatment for all
shareholders and forbids oppression of
minority shareholders.
Other aspects
Overlaying these specific shareholder actions,
English company law establishes general
duties or obligations that directors owe to
shareholders.4 They comprise the duty to act
for the benefit of the members of the company,
the duty to act in good faith and the duty to
exercise skill, care and diligence. These duties
serve as a foundation for corporate governance
but, in practice, are not an effective means
for shareholders to compel directors to pursue
the corporate purpose. It is very difficult
for shareholders to sue directors of English
companies because the circumstances in
which such a suit is permitted are not
clearly defined.
English company law also includes a
considerable number of detailed provisions
to regulate the activities of directors where
they face a conflict of interest. These laws
address specifically those situations where
directors have obvious incentives to further
their own interests or the interests of someone
other than the shareholders. Such rules
contribute to ensuring that directors do not
enrich themselves at the shareholders’
expense. Most of them make breach of the
rules a criminal offence, implying that
enforcement of the rules is primarily by
the state authorities, not by shareholders.
However, state enforcement of these rules is
not regarded as having been effective.
Board processes
At the next level down in the organisation,
the governance issue that faces BP Amoco’s
board is what it should do to ensure that its
delegate, the CEO, carries out the purpose
adopted by the shareholders.
Many aspects of the conduct and organisation
of its activities are not determined by English
company law. Consequently, a board has
considerable discretion about its role and
the way it organises its affairs. One may infer
that English company law established the
board as an essential link in the chain of
authority that begins with the shareholders
and extends throughout the organisation.
In recent years, the corporate governance
debate in the UK has supported this
inference and resulted in various quasi-legal
restrictions on the way in which boards of
UK-listed companies organise their work.
These restrictions have taken the
form of codes of “best” practice which have
been adopted by various regulatory and
shareholder bodies in their rules and
policies. For example, compliance with
the latest code, the Combined Code on
Corporate Governance (the “Combined
Code”), has become a condition of being
listed on the London Stock Exchange.
Furthermore, the Combined Code has been
the starting point for corporate governance
statements by many institutional investors
and their representative bodies. The codes
and statements give the non-executive
directors a primary role.
In 1997, in a resolution called the Board
Governance Policies, the BP Amoco board
recognised its obligation to shareholders to
ensure BP Amoco achieves the corporate
purpose. In governance terms, the BP Amoco
board therefore faces two tasks. On the one
hand, it has to ensure that in any of its own
work it fulfils the corporate purpose and, on
the other hand, that the CEO carries out the
corporate purpose in the work that it
delegates to him or her.
On the first task, a preliminary question
is how much of the general obligation to
shareholders can a board effectively carry
out itself? Given the part-time nature of the
BP Amoco board and its complex, collective
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decision-making process, the board can
realistically carry out very little of that
obligation. Almost all the work has to be
delegated to the CEO, who in turn delegates
parts of it to other full-time employees.
The pieces of work for which the BP Amoco
board has retained responsibility are, first,
to understand the shareholders’ view of the
corporate purpose, second, to account to
shareholders for the performance of the
company and, third, to find, direct, monitor
and remunerate the CEO.
The main way in which the board can
ensure that in its own work it achieves the
shareholders’ wishes is to function effectively.
To do so, a key requirement is that the board
needs to be able to operate independently of
the CEO and to be seen to do so. For this
reason, the chairman and deputy chairmen
of the BP Amoco board are non-executives.
It is for this reason as well that all work
involved in the board-CEO relationship is
delegated to committees comprised entirely
of non-executive directors. In addition, the
BP Amoco board has its own secretariat –
the office of the Company Secretary.
This office supports the board’s activities,
reports to the chairman and is not part of
the CEO’s executive staff. Other measures
bolster the independence of BP Amoco’s
non-executive directors include a limit on
length of service of ten years, a requirement
to resign to stand for re-election every
three years and access to advice from
outside sources.
The board’s second governance task is to
ensure that the CEO achieves the corporate
purpose with the authority delegated to him
or her. Another way of saying this is that
the board has to work out how to delegate
effectively. A key prerequisite for effective
delegation is to have a clear division between
the work of the board and the work of the
CEO. Assuming that both parties understand
and abide by the division of work, the tools
available to the board to ensure that the
CEO is carrying out the corporate purpose
are direction, monitoring and remuneration.
Direction covers specifying, at a level of
generality that the board itself can
realistically handle, the outcomes that are
expected for the company if it is to achieve
the corporate purpose. Direction also involves
setting out the means of delivering such
outcomes that are not acceptable. Monitoring
compares the company’s performance and
actions of the CEO (and those who work
for him or her) with the board’s directions.
Lastly, remuneration is perhaps the most
important means available to the board where
it is possible to include efficient incentives
in the remuneration of the CEO. In the case
of a listed company such as BP Amoco,
where the company’s shares are valued by
the market constantly, it is easier to
incorporate into the CEO’s remuneration
an element that is linked to changes in
shareholders’ wealth. Such incentives, if
genuinely linked to performance, are now
encouraged by the UK corporate governance
codes that have emerged in recent years.
Conclusion
From this survey, it can be seen that law
in many forms does play an important part
in the processes by which those who act for
an English corporation are required to
achieve the corporate purpose. For English
companies, statute and common law play
a greater role in the relation between
shareholders and directors than in the
relation between the board and the CEO.
Conversely, contract is the main form of law
that is found in the relation between a board
and the CEO. Although law often plays no
direct part in the means of governance that
depend on markets, such as the financial
markets, those markets would not function
without a substantial legal infrastructure.
Given the enormous variety of UK
organisations that use the legal vehicle of
a company for the purpose of facilitating
their activities, it is probably not useful
for law to prescribe in great detail how the
activity that takes place in such organisations
should be arranged. Room must be left for
the parties themselves to solve the problem
of governance in the way that best suits
their needs – in the words of the economist
F.A. von Hayek, for order to emerge
“spontaneously”. Fortunately, English
company law is largely facultative and
does allow considerable room for the parties
involved to design the best system for
their needs. However, none of these legal
systems would function at all unless English
society operated on the basis that everyone,
no matter how wealthy or powerful, was
under the law.
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4 The law says these duties are owed to the
“company”. In practice, they can be enforced
only by the shareholders.
* Rodney L. Insall
Vice President Corporate Governance
Company Secretary’s Office
BP Amoco p.l.c.
1 Finsbury Circus
London EC2M 7BA
UK
Tel: +44 20 7496 4666
Fax: +44 20 7496 4678
E-mail: [email protected]
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Corporate governance in westernEurope: structures and comparisons
Legal techniques for regulating corporate governance practices in Europe
serve goals that are linked to financial market development and share
ownership patterns. The following article summarises the corporate governance
implications of an investigation into ownership structure in Europe.
Eddy Wymeersch, Professor, Financial Law Institute, University of Ghent*
This article offers an overview of the areas
at the heart of the corporate governance
debate in western Europe. These areas
include the ownership and control structure
of firms, and the regulation of both relations
among shareholders as well as those which
link shareholders, the board and management.
The strength of financial markets is a direct
function of distribution of influence over
corporate affairs. Two different patterns
emerge. On the continent, the board is
dominated by the shareholders, and therefore
governance instruments are used to
counterbalance this influence. Financial
markets are weak and regulation attempts
to avoid dilution of the interests of major
shareholders. In the UK, the opposite occurs:
while financial markets are stronger,
shareholders are dispersed; boards are
dominated by management, and governance
techniques serve to limit the management’s
influence and strengthen the rights of the
shareholders. Strikingly, the same instruments
are used for totally different objectives.
Enterprise structure
Enterprise structure in western Europe
presents divergent patterns. Private business
firms can be contrasted with government-
owned or government-operated business
entities. The latter are in the process of
privatisation, and therefore are confronted
with important issues of corporate governance.
The private firms have developed different
governance patterns: these differences are
linked to historical, economic and political
differences, often referred to as “cultural”
factors. However, in addition, differences in
the ownership structure can be characterised
as a determining factor that has guided the
development of governance structures to what
they are today. These differences should not
mask the increasingly apparent fact that
governance structures tend to develop towards
a comparable scheme: the changing ownership
structure (in this case, the increasing role of
the securities markets), and therefore the
firm’s reliance on investors, owners of publicly
traded securities, may be considered to be
one of the main forces behind this drive
towards de facto harmonisation.
Comparing governance structures in a selected
number of European states about five years
ago, we concluded that there was a vast
difference in ownership structure between the
continental European states and the UK. From
in-depth research undertaken at the University
of Ghent,1 based on the declaration of major
holdings by shareholders who own 5 per cent
or more of the shares traded on the stock
exchanges, it appeared that in most of
continental Europe, listed companies were
dominated by one party, or by one or two
parties acting in concert. One can infer that
a fortiori the same situation prevails in
unlisted companies. However, some significant
differences appeared between the states, as
illustrated in the table below.
Germany, Italy and Belgium present a picture
of a closely held corporate system: most
companies are controlled by one party (over
50%) while only a handful are fully traded
on the market, with no shareholder apparently
controlling more than 25% of the shares.
The intermediate category (25% to 50%) is
the minority-controlled firms. Often de facto
control will be reinforced by the existence of
anti-take-over provisions. If more than one
party is in a controlling position, defection by
one of them may lead to a full change of
control, due to the mandatory take-over rule.
Although a comparable picture appears
for the next three states, they can be
distinguished. Switzerland presents a
two-track system: large, publicly traded
companies are listed alongside family-
controlled firms. The same applies to
the Netherlands and, to a lesser extent,
to Sweden. In the last two cases, the use
of protective devices (multiple voting rights,
non-voting depository receipts, etc.) may give
a misleading impression: although control is
still firmly held in the hands of a few parties,
securities are widely traded. France, on the
other hand, seems to follow a somewhat
more Anglo-Saxon model: this may be due
to the continuous efforts of the authorities
to bring additional shares to the markets,
Ownership concentration in Europe
D B2 I CH SW3 N F UK4
over 50% 68 68 66 55 45 44 37 7
25% to 50% 21 26 19 17 39 20 32 12
under 25% 11 6 15 28 16 36 31 81
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while privatisations have taken place without
retention of controlling blocks.
The pattern presented by the UK is striking:
it is almost exactly the opposite of the
continental European one. Although the
research only related to the 500 largest UK-
listed companies, it indicates that the vast
majority (81%) have no controlling or other
influential shareholder. With this varied
landscape as a background, one can therefore
expect governance mechanisms and
philosophies to be different.
Corporate governance
Corporate governance deals, among other
things, with the distribution of power and
influence within the business structure.
In the continental European system, where
most firms have a dominant shareholder, the
power will be exercised by this shareholder.
According to the law, the proper interest
of the firm will be in the hands of the board,
or by delegation, of the management. Hence,
governance mechanisms tend to ensure that
this overwhelming power of the major
shareholder is exercised not in his exclusive
interest, but also that due account is taken
of the interests of the other shareholders and,
in a more recent development, of the
stakeholders, the other parties affected
by the firm’s life.
In the Anglo-Saxon systems, the opposite
relationship prevails: in the absence of a
dominating shareholder, the management,
which dominates the board, exercises the
power. The potential is for the interests
of the shareholders to be sacrificed to those
of the management. Governance techniques
will therefore be used to curtail excesses by
management and to protect investor value.
It is striking that in developments in
corporate governance for private sector firms
the same tools – for example, increased
disclosure, independent directors and
internal committees – have been called upon
to achieve a better balance of power in both
systems. In each case, these instruments
serve as countervailing instruments, aimed
at ensuring a better balance in the interests
of “third” parties: investors, stakeholders and,
according to some, even those of the firm itself.
Corporate governance issues also arise
in government-owned firms, including
non-profit organisations.
Government-owned or government-dominated
firms are confronted with conflicting
objectives between the interest of the
government, as keeper of the general good,
and the interests of the firm. Decisions
imposed on the firm in order to achieve
public policy objectives of the government
lead to a weakening of the firm, and in the
longer term to its disappearance, often by
way of “privatisation”. Other factors may
result in a similar outcome: political
influences both at the level of policy and
of specific decisions, or with respect to the
appointment of managers or employees,
may not only weaken the organisation but
in the longer term may also jeopardise its
original mission.
In the non-profit sector, rules of good
governance are sanctioned not by economic
success but by weaker instruments of
measurement such as a reputation standard:
poor governance practices result in public
scandal, loss of credibility and possibly
dismissal of the board members or even
dissolution of the body involved. Recent
developments in the International Olympic
Committee, the Football League or even the
European Commission illustrate this finding.
Therefore, governance issues are common
to many human organisations, and deal
with ensuring that the persons appointed
to achieve a certain aim do not diverge
and do not serve other interests, whether
their own, those of third parties, or of some
(but not all) of their principals.
Ownership structure is evidently linked
to the development of the securities markets.
If shares of listed companies are held by a
handful of shareholders, market liquidity will
suffer and hence investors are less motivated
to invest in those shares.
This relationship can quite easily be
illustrated by comparing the market
capitalisation in the same states with their
overall economic importance, measured
in terms of GDP. The three most significant
European economies – Germany, France and
Italy – account for 58% of the overall GDP.
However, in terms of market capitalisation,
they stand for only 31%. The opposite
relation exists in the UK: here capitalisation
largely exceeds GDP (136%) while in relative
terms, the UK, although standing for only
11.6% of Europe’s GDP, lists 35.5% of
Europe’s overall market capitalisation.
This relative imbalance has significant
impact on institutional developments: states
with relative underweighting of share
business will have less developed markets
and, as a consequence, market regulation.
The UK has a very sophisticated system
of market regulation, which has stood
as a model for many other European
regulators. The stronger markets will drive
for deregulation: the UK has been the source
of inspiration for much of the Investment
Services Directive, while the Latin European
states have sought to protect their markets
by regulatory devices.5
In all European systems, shareholders, at the
general meeting, formally have the final say
in corporate affairs. Reality is quite different.
1 See E. Wymeersch, "A Status Report on
Corporate Governance in Some Continental
European States" and in K.J. Hopt, a.o. (ed.),
Comparative Corporate Governance, (OUP, 1998).
2 For Belgium, this figure relates to shareholders
acting in concert; for the sole controlling
shareholder the figure is 44 per cent.
3 At the 20 per cent level.
4 A sample of 425 companies.
5 See B. Steil in The European Equity Markets,
(Royal Institute of International Affairs, 1996),
esp. ch. 4.
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In many – even large – companies, controlling
shareholders will decide fundamental issues.
Investors have little or no influence on decision-
making. Sometimes, they will be confronted with
decisions taken by the controlling shareholder
that are not necessarily in the interest of all
shareholders. Hence rules have developed to
streamline this threat: most significant are
the rules on groups of companies, which have
been formally developed in Germany but
exist – although in a more flexible form – in
several other EU states.6 In addition, there
has been widespread acceptance – in the
future to be imposed by EU directive – of the
mandatory take-over bid, whereby the
acquirer of a controlling block – typically
one-third of the shares – is obliged to bid for
all the remaining shares, thereby offering a
withdrawal right to all shareholders.
As more companies are relying more heavily
on the securities markets for financing, the
role of the investor as a shareholder will
receive more attention: new mechanisms for
corporate suffrage are being developed,
whether by introducing more efficient proxy
voting systems, holding remote general
meetings or by voting electronically.7
Disclosure standards, also in terms of
internationally comparable accounting rules,
will have to be updated. An integrated,
comprehensive disclosure policy will have
to be developed. In general, accountability to
the new investor, especially the institutional
investor, is one of the key themes of new
governance rules.
Institutional investors
With the development in the institutional
environment, is there evidence of different
ownership patterns and investor behaviour?
Institutional investors have been accumulating
ever-larger holdings in listed companies.
However, there is no evidence that domestic
institutional investors have built up
significant stakes in listed companies:
reported holdings exceptionally exceed
the 5 per cent threshold. The composition
of their aggregate portfolios showed an
involvement of about 20 per cent of the
overall market capitalisation. These findings
do not exclude the fact that in some
companies institutions hold larger blocks,
as appeared in some of the recent French
and Italian take-overs.
The influence of institutional investors
on governance mechanism has remained
weak: there is some anecdotal evidence that
in some cases, in the UK especially, they
have been able to influence selection or
dismissal of board members, auditors,
mergers or acquisitions. On the continent,
they have mainly addressed anti-take-over
mechanisms put for approval at the general
meeting. Such action has received extensive
media coverage.
Board of directors
In the 1990s, the corporate governance
debate in Europe has focused mainly on
the effectiveness of the board of directors.
Several working parties have been
constituted, and several study reports
or recommendations on “good practice”
or “good conduct” have been published.
These are known under the names of the
respective chairperson: in the UK, the
Cadbury report has outlined the terms of
the discussion and stood as a model for
similar initiatives all over the world. It was
further refined in the Greenbury and Hampel
reports. In France, a first Viénot report
formulated rather gentle recommendations
which, in a recent document,8 were rendered
more stringent. In the Netherlands, the Peters
report contained recommendations for
improved functioning of the supervisory
board, but later developments may lead to
more fundamental change in the structure
of the board. All this indicates that the issues
relating to the structure and function of
the board are provoking different responses
in different European states, and that no
single scheme is likely to emerge as
predominant. This diversity can be attributed
to the range of factors that influence the issue
of governance. However, the central issues
remain the same. These central and similar
features of corporate governance systems are
described below.
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In most European states, it is a common
feature of listed companies that they are
governed by a board of directors, the members
of which are elected at the general meeting
of shareholders. The board is mainly in
charge of deciding on policy issues, appointing
and monitoring the management, including
pay. It is accountable to the shareholders,
who have the right to dismiss its members
at will. In practice there are wide differences
as to who effectively appoints the directors.
In systems with controlling shareholders,
directors will be appointed at the general
meeting, which is de facto by the controlling
shareholder. Boards that are generally
subservient to the controlling shareholder
will be ineffective in balancing the interests
of the other shareholders against those
of the controlling shareholder. Although
such a company’s shares are listed and traded
on public markets, it is argued that these
companies are run in the interests, not
of the investors as a group, but of their
important shareholders. Responses to these
allegations have been sought on a wide
range of governance instruments: from
specific disclosure, especially on intra-group
dealings, to stricter rules on the laws
regulating such groups. The more modern
techniques of corporate governance include
the appointment of independent directors or
specialised committees to deal with a group’s
internal conflicts of interest. Some legal
systems have extended the rules on conflicts
of interest to incorporate the relationships
with the controlling shareholder, while others
have introduced mechanisms urging
the controlling shareholder to take over
all the remaining shares.
In systems without controlling shareholders,
the board is composed on the initiative of
management or of the incumbent board
members: de facto co-optation and cronyism
might result. Independence of judgement is
pursued by appointing a significant number
of independent directors, or even a majority
of independent directors. However, question
marks are raised with respect to their
independence: often, CEOs offer one another
reciprocal invitations to sit as so-called
“independent” directors on their respective
boards. Such reciprocity may reduce their
ability to constitute an effective
countervailing force.
In both cases, corporate governance
recommendations have included a number
of reforms that point in the same direction.
The central recommendation would be
that the board has to remain in full control
and should take care of the interests of
the company and of all its shareholders.
To avoid one of the parties concerned
having too strong an influence, the same
techniques are used, namely, the appointment
of independent directors, the organisation
of internal board committees and the
separation of the functions of chairman
of the board and CEO.
Similar issues have arisen in companies
that have formally split supervisory and
management tasks. This structure is best
known in the German and Dutch examples,
although it is practised in several other
states. The larger companies must appoint
a two-tier board: one board is in charge
of supervision of the company, the other
of managing the company. The tenure of
membership of the supervisory board
is different from that of the managing board.
Although the members of the latter are
appointed by the supervisory board, they
have considerable security in running
the company as they see fit. They are better
protected against dismissal than members
of the supervisory board because their
dismissal is not at will. The supervisory
board members are effectively appointed
by individual shareholders, and therefore
have to ensure that their will is respected
by their “sponsoring” shareholder.
In these circumstances, the independence
of supervisory board members becomes an
issue because they are often not independent
enough of one shareholder to serve the
interests of all shareholders. Both in Germany
and in the Netherlands some form of labour
co-determination has been introduced
in the supervisory board: in the German
structure, half of the supervisory board
members are appointed by the workforce,
while in the Netherlands, members are
appointed by co-optation, without being
representatives of the workforce.
Decision-making control
The fundamental issue involved in
the governance discussion concerns the
relationship of these governing bodies
to the company, the entity to which they
owe their legal duties.
If one further pursues the distinction
mentioned above, i.e., between companies
that are controlled by one or a few parties,
and those that have no controlling shareholder,
a certain number of consequences follow.
In tightly controlled companies, the board’s
decision-making freedom and that of the
management will be restricted. A controlling
shareholder may impose decisions or deny
opportunities, either in its own interest
or that of its group. The board will have a
largely supervisory role, strictly supervising
the management and authorising major
decisions. These conditions for governance
are likely to have a measurable impact on
the management’s freedom to decide on issues
such as substantial investment projects,
or on the management’s own remuneration.
6 For comparative overviews of the law relating to
company groups, see P. Balzarini, G. Carcano,
G. Mucciarelli, I Gruppi di Società, 1996, 3 vols,
(Guiffè Editore, Milan); M. Lutter (ed.),
“Konzernrecht im Ausland”, Zeitschrift für
Unternehmens- und Gesellschaftsrecht,
Sonderheft 11, (De Gruyter, Berlin, 1994); E.
Wymeersch (ed.), Groups of Companies in the
EEC, "A Survey Report to the European
Commission on the Law Relating to Corporate
Groups in Various Member States",
(De Gruyter, Berlin, 1993).
7 For a comparative overview, see Baums and
Wymeersch (eds.), Shareholder Voting Rights
and Practices in Europe and the United States,
Kluwer (forthcoming) 1999.
8 See AFEP – Medef, "Rapport du Comité sur le
Gouvernement d'entreprise présidé par M. Marc
Viénot", July 1999.
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If investments require additional financing,
the controlling shareholder may fear that a
share issue will dilute its holding. However,
it may be that such a shareholder prefers
debt financing. A certain form of financial
strangulation may result, restricting the
growth of the business.
The governance debate has identified a
certain number of remedies: the usual
instruments against conflicts of interest have
been developed, but are often insufficient.
Governance techniques, such as the
appointment of independent directors,
the organisation of specialised committees
with independent directors, rules on related
party transactions, and also contractual
techniques leading to greater freedom for
management, have been introduced in
several states. Others have, for different
reasons, sought to subdivide the governance
structure between two boards, whereby the
management obtains greater freedom, while
the shareholder influence is formally restricted
to supervision. In Germany, the power of the
shareholder has been reduced by allowing
more influence to the workforce: management’s
initiative is favoured, except when it runs
contrary to the interests of the workforce.
This pitfall was avoided in the Dutch system,
where the supervisory board contains no direct
representatives of the workforce. Largely
unrestricted by the shareholders, management
obtained wide freedom, and Dutch companies
have grown at a considerable pace.
In companies without strong shareholders,
management dominates decision-making.
The priority is growth, leading to strong
expansion, and, in some cases, to global
business activity. Financing of major projects,
including take-overs, is not restricted by the
shareholders. An aggressive take-over market
supports and permits this conduct. At the
same time, management in these conditions
has a tendency to overreach, whether by
engaging in excessive projects, allowing itself
compensation that exceeds its added value,
or by weak supervision of the business
development. Collapses occur, often in the
form of a take-over bid.
Countervailing forces are found in these
systems and also in the traditional
governance instruments, mainly aimed at the
reduction of the power of the management.
The appointment of independent directors,
the appointment of a chairperson distinct
from the CEO, the organisation of committees
of the board, and more scope for shareholder
involvement (“shareholder democracy”)
are all tools for strengthening the board’s
supervisory function. The markets, thriving
on extensive disclosure, will collectively
and more explicitly monitor their conduct.
Institutional investors appear recently to be
eager to get a stronger hold on management,
with the objective of making up for the
supervisory deficit.
Conclusions
Governance structures in western Europe
have developed against a background
of certain factual developments. They are
thereby the product of historical and
sociological factors, and present a large
variety of schemes. At a detailed level,
it might appear that the ownership and
control of enterprise is specific to western
Europe and even particular states. However,
at a general level, there are similar forces for
change in both the transition economies and
western Europe that make the observations
and specific experiences outlined above
relevant to corporate governance in transition
economies. For example, the transfer
of ownership from the state to the private
sector, from a single-family owner or related
group of shareholders to a body of dispersed
shareholders (including institutional and
foreign shareholders) will no doubt be a
feature of both systems. The participation of
employees in the future economic well-being
of enterprise – whether that be by way of
employee share ownership, or a form of co-
determination or information sharing – is a
common general issue that may be tackled
using different governance techniques.
Conflicts of interest are, of course, pervasive,
and the experience of western Europe in
seeking to reduce these to optimal levels will
continue to be important. Generally, the
inheritance of a civilian legal tradition should
make intelligible some of the regulatory tools
employed and still in development
to cope with the goals of well-governed
private sector enterprise. At least some
of their features might interest and inspire the
regulators and business communities in the
transition economies.9
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9 For further on this subject, see D. Green and K.
Patrick (eds..), The Future of Banking Supervision
and Regulation in Selected Transitional Economies
in Relation to EMU, to be published by Edward
Elgar Publishing, 1999; see also, E. Wymeersch,
footnote 1.
* Eddy Wymeersch
Professor
Director Financial Law Institute
Universiteit of Ghent
Universiteitstraat 4
B-9000 Gent
Belgium
Tel: +32 9 264 68 27
Fax: +32 9 233 28 46
E-mail: [email protected]
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Patient pension capitalLarge pension funds held in trust for millions of future retirees currently represent a growing
source of patient capital for business investment. Political, cultural and social distinctions,
as well as the usual investment criteria are becoming increasingly relevant to the investor
who must consider possible diversification into many different countries. The following article
explains how CalPERS, the largest pension fund in the United States, goes about the serious
business of determining how to diversify investments globally over the long term. This example
of international investment policy development is sharply focused on some of the considerations
that must be made in the transition to a more global economy.
William Dale Crist, President of Board of Administration, and
Kayla J. Gillan, General Counsel, California Public Employees’ Retirement System*
The corporate form of business organisation
is critical to continued economic development
and job creation throughout the world.1 To be
successful in an increasingly competitive
economy, stay abreast of technological change
and accomplish normal growth, corporations
need reliable and affordable sources of
capital funds. This article will discuss the
increasing importance of pension funds as
a source of this capital, and the way in
which one US fund – the California Public
Employees’ Retirement System (CalPERS) –
makes decisions regarding allocation of its
capital to markets around the globe.
Background
Today, US pension funds control financial
assets of more than US$ 6.7 trillion, an
increase of almost 45 per cent since 1994.2
Retirement systems that provide benefits to
state and local government employees (known
as “public pension funds”) control over
one-third of these assets, or US$ 2.4 trillion.3
US investors hold over US$ 432 billion in
non-US equities, with the largest 25 US
pension funds holding US$ 181.1 billion of
that amount.4 While general US investments
in foreign markets has increased at a
relatively modest 10 per cent since 1996,
the US pension fund share of these foreign
investments is increasing more dramatically
(from 28 per cent of the total US-held foreign
equity in 1996 to 42 per cent by the third
quarter of 1998).5 Experts project that
US pension fund assets will grow by 6 per
cent over the next five years, contributing
to probable continued increases in cross-
border capital commitments.6
Pension fund trustees and professional
administrators must stay focused on the long
term. Funded retirement systems exist as
multi-generational entities with liabilities
that extend 40, 50 and even more years into
the future. Pension fund investment strategies
tend to reflect this very long-term viewpoint.
For example, as measured by turnover rates,7
pension funds – and most particularly public
pension funds – generally hold their equity
investments significantly longer than other
types of US investors.8
These data indicate the growing importance
of US public funds as a reliable source
of patient capital, now and into the future.
As discussed below, the CalPERS Board
of Administration and the System’s
professional administrators are fully aware
of the relationship between the long-term
liabilities of the fund they administer and the
importance of the capital funds they provide
to a competitive global economy.
CalPERS
With assets valued at over US$ 150 billion,
CalPERS is the largest pension fund in the
United States.9 CalPERS has achieved
double-digit returns for six of the last seven
years. For the past three-year period (ending
31 May 1999), CalPERS earned 16.3 per
cent on its investments; for the five-year
period (also ending 31 May 1999), the fund
earned 15.8 per cent.10
CalPERS’ mission is to ensure the retirement
and health security of its over 1 million
members.11 As a defined benefits system,
CalPERS’ assets are directly tied to the
benefits that must be paid to these members,
and their survivors, over their lifetimes. Based
on the expected ageing of the population, and
the impact of this global issue on CalPERS in
particular, the current US$ 150 billion in
assets approximates the amount, as measured
and forecast at this moment, that is needed to
meet CalPERS’ future benefit liabilities.12
One of the responsibilities of the CalPERS
Board of Administration is to determine how
the trust fund is to be allocated for investment
among various possible asset classes.13 Asset
allocation is the most important element of
CalPERS’ investment strategy, and is never
made in isolation. This critical decision must
be made – and periodically revisited – with
full view of the System’s future stream of
liabilities, employer and employee contributions
to the fund, and estimated future operating
costs. The Board’s goal is to maximise returns
at a prudent level of risk – an ever-changing
balancing act between market volatility and
long-term goals.14
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CalPERS follows a strategic asset allocation
policy that identifies the percentage of the
System’s funds to be invested in each asset
class. Policy targets are typically
implemented over a period of several years
on market declines and through dollar cost
averaging.15 CalPERS’ current asset
allocation mix16 by market value and policy
target percentages is shown in Table 1.
CalPERS’ commitment to non-US markets
began in 1986 with a 10 per cent allocation
(to both international equities and fixed
income). This commitment has steadily
increased so that, as demonstrated in Table 1,
20 per cent of CalPERS’ fund is currently
targeted for allocation to non-US equity
markets and 4 per cent to non-US debt
markets.17 In the Board’s view, investments
outside of the US are critical to obtain both
diversification and increased returns.18
To date, all of CalPERS’ international
investments have been managed by outside
firms hired by CalPERS for this purpose.
These managers are selected based upon
their style (e.g., passive vs. active, growth vs.
value) and regions of expertise (e.g., Europe
vs. Asia). Once selected, the firms are
delegated discretion for the assets under their
control. This discretion is limited, however,
by two factors. First, in the usual fashion
the managers’ compensation is directly
linked to specified performance benchmarks.
To the extent a particular country’s market
is excluded from the benchmark index, the
manager may be less inclined to invest
CalPERS assets in it. Secondly, the CalPERS
Board has affirmatively determined that
certain countries’ markets are outside the
scope of the managers’ discretion; that is,
they may not make equity and/or debt
investments in them. Further, the Board has
also determined that certain other markets
pose a sufficient degree of relatively higher
risk to justify limiting the managers’
discretion to invest in them; in other words,
the manager may invest in such markets,
but only to an expressly limited degree.
CalPERS is the only known US pension fund
that specifically controls its non-US investments
to this extent.19 This policy of control within
CalPERS is implemented through its
“Permissible Country Programme”, which
is the topic of the remainder of this article.
CalPERS’ “permissiblecountry” process20
CalPERS’ Permissible Country Programme
does not seek to determine the relative
attractiveness of specific markets. CalPERS
delegates this determination to its external
asset managers. Rather, the Programme seeks
to identify those markets that, in the opinion
of the CalPERS Board, are “safe” enough
to support institutional investment practices
by a very large defined benefit public
pension fund.
CalPERS retains an outside consultant21
to assist in the evaluative process that leads
to identification of “permissible countries”.
With respect specifically to equity investments,
the consultant suggests that eight broad
categories capture each market’s opportunity
and risk factors.22 The relative importance of
each category is weighted, and the sum of the
weighted categories represents the consultant’s
overall evaluation of each market/country.
The Table 2 depicts all eight categories,
with their weightings; the discussion below
describes each factor more specifically.
Within each of these eight macro-categories
is a series of micro-factors:
1. The political risk category analyses the
risk to foreign investors resulting from political
changes in a country that can have a negative
impact on market openness, liquidity or
performance. Markets with apparently stable
and democratic political systems, and those
committed to supporting foreign investment,
are ranked high. Markets with political systems
judged to be unstable are ranked lower. Each
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0
1000
1991
2000
3000
4000
5000
6000
7000
8000billions $
State & local government employee retirement funds
Private pension funds
Source: Board of Governors of the Federal Reserve System
1992 1993 1994 1995 1996 1997 1998
Amount of US pension funds over past eight years
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country’s sovereign credit rating is also analysed,
as a reflection of a country’s stability, and its
willingness and ability to repay its debt.
2. When analysing market liquidity and
volatility, the consultant seeks to measure
the ability of an investor to sell assets in a
country in a manner that is timely and does
not adversely affect security prices. Other
factors indicative of stock market return
volatility are also evaluated.23
3. Country development is a very broad
category. First, GDP per capita is used to
measure the economic strength of a country,
and is a general measure of wealth.
Wealthier countries tend to have better
developed financial infrastructure and,
generally, present less overall risk to foreign
investors. GDP per capita is assigned the
highest micro-factor weight within this
category. Other lower weighted micro-factors
are average annual GDP percentage growth;
the health of the country’s banks; level of
education in the labour force; labour force
productivity; and population literacy rates.
4. Market regulation/legal system/investor
protection is assigned the heaviest weighting
because, under the current CalPERS
Permissible Country Programme, it represents
the key to a country’s investment climate.
The micro-factors within this category seek to
measure the degree to which foreign investors
are legally protected in each market, through
regulations and the existence of shareowner
and creditors’ rights. The role of a dedicated
market regulatory agency, as well as each
Table 2
Category Assignedweight (%)
1 Political risk 10
2 Market liquidity/volatility 15
3 Country development 10
4 Market regulation/legal system/investor protection 20
5 Investment restrictions 15
6 Settlement proficiency 15
7 Transaction costs 5
8 Year 2000 compliance, technological growth 10
Source: Wilshire Associates Inc., Permissible Country Equity Investment – Analysis and Recommendations
(April 1999).
Table 1
Asset class Market value Current allocation Target(US$ billion)
Cash equivalent 2.2 1.4% 1.0%
Fixed incomeDomestic 35.7 23.1 24.0International 5.8 3.8 4.0
Total fixed income 43.7 28.3 29.0
EquitiesDomestic 70.6 45.6 41.0International 28.2 18.3 20.0Private equities 4.7 3.0 4.0
Total equities 103.5 66.9 65.0
Real estate 7.4 4.8 6.0
Total fund 154.6 100.0 100.0
1 See Organization for Economic Co-operation and
Development, Principles of Corporate Governance
(1999), p.5.
2 Board of Governors of the Federal Reserve
System, Flow of Funds Accounts of the United
States, Flows and Outstandings, First Quarter
1999 (11 June 1999), at tables L.119 and L.120.
3 Id. at table L.120.
4 The Conference Board, Institutional Investment
Report: International Patterns of Institutional
Investment, Vol. 3, No. 1 (May 1999).
5 Ibid.
6 InterSec Research Corp., as presented to
CalPERS International Investment Workshop (April
1999, available from CalPERS). InterSec predicts
that US pension assets will total US$ 8.3 trillion
by the year 2003, and that the percentage of
these assets targeted for cross-border
investments will grow from 10 per cent in 1998
to 14 per cent five years later.
7 “Turnover rate” refers to the rate at which equity
shares held by the fund are traded.
8 The Conference Board, Institutional Investment
Report: Turnover, Investment Strategies and
Ownership Patterns, Vol. 2, No. 2 (August 1998),
p.11. (In 1997, the annual turnover for all
investors trading on the New York Stock Exchange
(NYSE) was 46 per cent. Public pension fund
turnover, weighted by value of portfolio, averaged
only 19.3 per cent. Private pension fund turnover
was higher, at 36.3 per cent, yet still below the
total average.)
9 Top 200 Pension Funds/Sponsors, PEN. & INV.,
(25 January 1999), p.30.
10 “CalPERS Facts at a Glance: Investments”
(July 1999) (available at www.calpers.ca.gov/
about/factglan/investme/investme.htm)
(visited 6 August 1999).
11 CalPERS’ Mission Statement (adopted March
1996) (available at www.calpers.ca.gov/about/
mission/mission.htm) (visited 6 August 1999).
12 “CalPERS Projected Future Fund Flows” (February
1999). See also Organization for Economic
Co-operation and Development, “Maintaining
Prosperity in an Ageing Society” (OECD Policy
Brief No. 5, 1998).
13 Cal. Gov. Code §§. 20090, 20120, 20190.
14 “CalPERS Asset Allocation” (July 1999) (available
at www.calpers.ca.gov/invest/asset/asset.htm)
(visited 6 August 1999).
15 Ibid.
16 Supra note 10.
17 “CalPERS’ Historical Asset Allocation Policies”
(February 1999).
18 CalPERS’ International Investment Workshop
(April 1999).
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Chart I
CalPERS’ fixed income permissible country list (effective 14 June 1999)
Appropriate Maximum 5%* ProhibitedAustralia Chile Argentina Austria Czech Republic BrazilBelgium Greece ChinaCanada Hong Kong (SAR) ColumbiaDenmark Hungary EgyptFinland Israel IndiaFrance Poland IndonesiaGermany South Africa MexicoIreland South Korea PhilippinesItaly Taiwan Slovak RepublicJapan ThailandLuxembourg Turkey The Netherlands VenezuelaNew ZealandNorwayPortugalSingaporeSpainSwedenSwitzerlandUnited Kingdom
* Maximum 5 per cent indicates that the collective proportion comprising these countries may not exceed 5 per cent of the portfolio managed.
Authorised list notwithstanding, credit ratings and liquidity considerations must meet the criteria in the manager’s investment management guidelines.
CalPERS’ equity permissible country list (effective 14 June 1999)
A B CAppropriate Limited exposure* ProhibitedAustralia Argentina China Austria Brazil Colombia Belgium Chile EgyptCanada Czech Republic HungaryDenmark Greece IndiaFinland Indonesia JordanFrance Israel KenyaGermany Korea MoroccoHong Kong Malaysia** PakistanIreland Mexico PolandItaly Philippines Russia Japan Peru Slovak Republic Luxembourg South Africa Sri LankaThe Netherlands Taiwan VenezuelaNew Zealand Thailand ZimbabweNorway TurkeyPortugalSingaporeSpainSwedenSwitzerlandUnited KingdomUnited States
* CalPERS instructs managers to limit exposure to group B in total to 20 per cent of the aggregate portfolio of broad non-US equity mandates that permit exposure to the
emerging markets. In addition, specific countries in this category should not exceed two times their market capitalisation weight or 5 per cent of the portfolio, whichever is
lower.
** Malaysia currently has capital controls in place and is not permitted for investment until these controls are lifted.
Chart II
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country’s laws, are reviewed to assess the
following equally weighted factors:
■ Adequacy of financial regulation: higher
scores reflect a strong agreement to the
statement, “Regulation and supervision of
financial institutions is adequate for
financial stability”.24
■ Bankruptcy/creditors’ rights: this factor
seeks to measure the adequacy of creditors’
rights in each market, in the case of
bankruptcy or reorganisation proceedings.25
■ Shareowners’ rights: higher scores reflect
stronger regulations regarding the legal
rights of equity holders to protect their
ownership interests (through proxy, judicial
and other avenues).
5. The degree of market openness to US
investment is a critical barometer of a
government’s commitment to free-market
policies. Countries with higher restrictions
on foreign investment receive a lower score.
6. Countries with automated trading and
settlement procedures, through which
transactions are settled in a timely and
efficient manner, receive a higher score.
7. The transaction costs factor measures the
costs associated with trading and includes
stamp taxes and duties, amount of dividends
and income taxed, capital gains taxes and
commission rates.
8. Year 2000 compliance and technological
growth looks primarily at the degree to which
a country’s companies are expected to suffer
mission-critical systems failure,26 and then at
its ability to absorb new technology.27
Using the scores derived through this process,
the CalPERS Board makes three critical
decisions. First, the Board identifies those
countries/markets in which it is appropriate
for CalPERS’ managers to exercise unlimited
investment discretion. Secondly, the Board
identifies those countries/markets that
represent a relatively higher degree of risk
for institutional investment, thereby limiting
investment managers in their ability to make
investments.28 Finally, the Board identifies
those countries/markets that are, at the time
of the list compilation, inappropriate for
any CalPERS manager to invest. By default,
every country not on one of the two earlier
lists is considered to be in this last category.
Moreover, each of these policy determinations
are, of course, made effective on the date the
final Permissible Country Programme “list” is
adopted, and subject to change as conditions
in the various country markets change.29
Conclusion
CalPERS’ Permissible Country Programme
probably is unique among US public pension
funds. However, as US investment in non-US
markets continues to expand, other large
institutional investors may adopt similar
programmes. When any country’s laws,
regulations, political stability, business
culture or market practices impose relatively
greater risk on foreign investors than is the
case in other available markets, it will
become increasingly difficult for the more
risky market to attract new capital funds. Better,
more rapid communication, improved company
and market transparency, and the increasingly
global nature of competition for capital funds
will promote more thorough analytical
approaches to evaluating foreign investment
opportunities. There is no longer any capital
market that can exist as an island in the new
sea of global competition, and no institutional
investor that can afford to avoid at least
considering the risk-adjusted investment
opportunities that may be found in every
corner of the world.
19 CalPERS surveyed 20 large US public pension
funds. Only one, the New Jersey Division of
Investments, uses a prudent country list explicitly,
and its list is based on credit ratings only. The
Minnesota Board of Investment uses international
investment guidelines based on worker and human
rights issues as reported by the US State
Department. These guidelines are not exclusionary
but require managers to present their rationale
for investing in certain countries. The remaining
respondents to the survey that have international
investments indicated they do not use permissible
country lists or use an index for the approved list.
20 The authors wish to note that the CalPERS Board
is, at the time of writing this article, re-examining
its Permissible Country Programme. Thus, the
process, criteria and weightings discussed herein
may be changed at some time in the future.
21 Wilshire Associates Inc.
22 Wilshire Associates Inc., Permissible Country
Equity Investment – Analysis and Recommendations
(April 1999).
23 These other factors include average daily trading
volume; size and relative change in market
capitalisation; return volatility (as measured by
standard deviation); number and growth of listed
companies; and return/risk ratio.
24 As reported in World Economic Forum Global
Competitiveness Report (1997).
25 Ibid.
26 As reported by JP Morgan, “January 1, 2000:
Ready or Not!”.
27 Supra note 23.
28 Specifically, CalPERS’ equity managers must limit
total exposure to this group of countries to no more
than 20 per cent of the aggregate portfolio of broad
non-US equity mandates that permit exposure to the
emerging markets. In addition, investments in
specific countries in this category may not exceed
two times their market capitalisation weight, or
5 per cent of the portfolio, whichever is lower.
Similarly, the collective proportion of CalPERS’
fixed income managers’ portfolio comprising these
countries may not exceed 5 per cent of the
portfolio managed.
29 Chart I includes CalPERS’ current Permissible
Country List (Equity). Chart II includes the
Permissible Country List (Debt).
* William Dale Crist, Ph.D
President of Board of Administration
Kayla J. Gillan, J.D.
General Counsel
California Public Employees’ Retirement System
400 P Street
Sacramento, CA 95814
USA
CalPERS
Office of Public Affairs
Tel: +1 916 326 3991
Fax: +1 916 326 3507
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Polish pension reform andcorporate governance issues
Pension fund capitalism has been cited as influencing the development
of corporate governance practices in the United States and the United
Kingdom. The following article explains aspects of the structural changes
to the Polish pension system and suggests, in terms of capital market
development, how these changes might affect corporate governance.
Lukasz Konopielko, The Central and East European Economic Research Center*
Introduction
The objective of this article is to highlight
the very basic landscape of the reform of
the pension fund system in Poland, and the
accompanying institutional change to
demonstrate how this development might
serve as a focal point for testing the health
of corporate governance in Poland. This
supposition is based on the experience of
domestic savings and investments systems
in developed markets, especially in the USA
and the UK where the proportion of pension
assets invested in equities was 46 per cent
and 63 per cent respectively.1 The following
sections cover: the economic environment
and the case for reforming the pension fund
system; the structural elements of pension
reform including fund collection and
investment activities; and some initial
observations of activity under the new system.
The article concludes by identifying areas of
emerging issues, and where the most pressing
of these is likely to develop in the future.
Economic background and case for reform
After much debate, a new three-pillar
pension system was implemented in Poland
on 1 January 1999. Among other factors,
the reform was introduced to facilitate the
process of joining the EU and in particular
Polish participation in monetary union.
State budgetary concerns are the main reasons
for these reforms, as social security spending
is viewed as a major factor contributing to
budget deficits and consequently high
inflation. In 1993 the budget subsidy for
the social security system amounted to more
than 12 per cent of budgetary spending,
while in 1996 it stabilised at a level of 6 per
cent. The previous pension system, based
solely on pay-as-you-go (PAYG) funding,
was generally regarded as unjust and obsolete.
In particular, the common view was that
benefits were not related to contributions.
Moreover, demographic predictions indicated
that this system was only sustainable for
another 10 to 15 years. Accordingly, the
reform of the social insurance system is
intended to rationalise the existing system,
introduce real links between contributions
and benefits, and diversify sources for
financing benefits.
There are also strong links between this
reform and other elements of the development
of the market economy. The envisaged flow
of funds, which assumes that part of currently
paid contributions will be capitalised,
requires significant acceleration of privatisation
in order to maintain budgetary deficit limits.2
Legislation on using privatisation revenues
for financing the pension system reform3
establishes the legal basis for these operations.
Accordingly, the acceleration of privatisation
coupled with the creation of new institutions,
i.e., private pension funds, are expected to
play a significant role in the governance of
invested public and particularly privatised
firms.4 Although investors’ appetite to finance
firms is likely to be biased toward debt over
equity for some time (see below), the
development of financial market discipline
fuelled by debt will influence the development
of corporate governance. However, the extent
of such influence will depend heavily on
existing regulations and emerging practices.
Reform spillovers are expected to occur in the
area of capital market development. New,
well-capitalised financial market institutions
– open pension funds – are created, which, it
is estimated, will be responsible for investing
around 1 per cent of GDP per year by 2010.
Even by 2000, they will receive in nominal
terms the equivalent of more than US$ 500
million. Although limited by the requirements
described below, a significant part of this is
expected to be invested on the Warsaw Stock
Exchange, which is currently capitalised at
around US$ 30 billion, with an average daily
turnover in 1998 of US$ 35 million.
The policy expectation associated with this
new system is that it should boost market
development because it will encourage new
firms to use various forms of external
financing partly based on pension funds
investments. Pension funds will thereby
become significant players in financial
markets. The potential discipline of the
financial markets on savings and investment
behaviour lies at the heart of the corporate
governance issues underlying the change in
the Polish pension system. Additionally,
potential benefits include those arising
from the impact on the asset distribution of
investment portfolios and on allocation
efficiency due to institutionalisation, financial
innovation and the creation of specialised
intermediaries providing financial services.5
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Pension funds
Within the new Polish pension system,
capitalised contributions are managed and
invested by specially licensed universal
pension funds companies, which will run
open pension funds. The Act on Organisation
and Activities of Pension Funds (APF)6
created the legal framework for establishing
and running pension funds companies, open
pension funds, as well as employee pension
funds. The pension funds are legal entities,
created for purposes of accumulating and
investing members’ money in order to supply
funds at retirement.7 Three most important
areas of their activities (receipts, organisation
and investments) are subject to regulations,
compliance with which is supervised and
enforced by a newly created regulator – the
Pension Funds Supervision Office (UNFE).
Receipts
The Act on Social Security System8 and Act
on Pensions9 profoundly reformed the Polish
pension system. In order to diversify the
sources of retirement benefits, a new, three-
pillar system was created. In the new system,
the first pillar is simply the previous public
system, the second pillar is based on private
open pension funds, while additional and
voluntary insurance and savings are contained
in the third pillar. The core of the reform is
therefore the creation of the second pillar,
as the other two elements existed previously.
Under the second-pillar open pension fund,
a contribution worth 7.3 percent of wages is
redirected to capitalised open pension funds.10
At retirement, members of these funds will be
obliged to purchase life annuities. However,
this pillar will only cover all workers on a
gradual basis. All persons starting their first
job as well as these aged below 30 in 1999
must enter the new system, while those aged
between 30 and 50 can choose either to stay
solely with the first pillar or to split their
contribution between the public first pillar
and second-pillar pension funds.
The new system clearly assigns property
rights to employees based on contributions
accumulated during their working lives.
Pension funds are obliged to provide
members with regular information (at least
once yearly) on their savings and the results
of investment activities.11 This information
has also to be disclosed on a member’s
request.12 Funds collected for pension funds
form part of a member’s personal estate
for transmission on death, unlike funds
contributed to the first pillar.13 This feature of the new system appeared to many to be
a significant factor for splitting contribution
between the first and second pillars.
Pension funds’ assets are kept by an
independent bank-depositor, which is subject
to a minimum Û100 million capital
requirement. The bank-depositor cannot be
a shareholder in the depositing fund and
cannot credit the fund for more than 1 per cent
of the fund’s assets.14 The collection activities
of funds are also directly regulated. In order
to eliminate excessive promotion costs, which
plagued similar funds in Chile and Argentina,
it is forbidden to offer any additional benefits
for joining the fund.15 A special register was
created by UNFE, listing all sales people
permitted to offer membership to funds.16
By mid-1999, the register contained more
than 400,000 entries. Each entry has to be
associated with a certain organisation.
Salespeople can be employed either by the
1 As in 1990. See P. Davis Pension Funds,
(Clarendon Press, Oxford, 1997).
2 For wider discussion of the implications of
pension reform on privatisation, see R. Charlton,
R. McKinnon and L. Konopielko, "Pension Reform,
Privatisation and Restructuring in the Transition:
Unfinished Business or Inappropriate Agendas?",
Europe-Asia Studies 50(8): 1413-1446, 1998.
3 Act on Using Privatisation Revenues on Financing
Pension System Reform of 25 June 1997.
4 See R. Gesell, K. Muller, D. Sub, "Social Security
Reform and Privatisation in Poland: Parallel
Projects or Integrated Agenda?", Frankfurt
Institute for Transformation Studies, Discussion
Paper No. 8/98, 1998.
5 See G. Impavido "Pension Reform in Eastern
Europe" Moct-Most 7: 101-135, 1997.
6 28 August 1997.
7 See Art. 2 of the APF.
8 13 October 1998.
9 17 December 1998.
10 See Art. 22.3 of the Act on Social Security
System of 13 October 1998.
11 See Art. 191 of the APF.
12 See Art. 192 of the APF.
13 See Chapter 13, Art. 131-133 of the APF.
14 See Chapter 16, Art. 157-165 of the APF.
15 See Art. 92 of the APF.
16 See Art. 93.3 of the APF.
57
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0
0.3
0.6
0.9
1.2
1.5millions
Membership number (in millions of people)
Orzel (PBK Bank)
Ego(BIG/Eureko)
Bankowy(PKO/Handlowy)
Skarbiec(BRE and Hestia)
ZurichSolidarni
NorwichUnion
AIGNationaleNederlanden
PZUBPH-CU-WBK
Membership of ten largest funds (estimated as of 15 July 1999)
Source: estimates based upon various issues of Rzeczpospolita
4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 57
universal pension company or by one of the
entities allowed by the APF. These are: banks,
insurance companies, brokers and State Mail.17
In addition, as part of the reform process,
the existing first pillar as managed by the
Polish Social Security Institution (ZUS) is
undergoing significant changes. Contributions
of each employee will be registered on their
individual account. The retirement age will
become an individual decision, with a certain
minimum retirement age. Furthermore, all
disability and survivorship benefits will
remain within this pillar. The second pillar
will therefore contribute only to pensions and
according to official forecasts 35-40 per cent
of future pension benefits will originate from
this source.18
Funds organisation
Companies and funds are licensed and
supervised by UNFE, and should fulfil
numerous requirements, including a minimum
capital value of Û4 million19 which must
be contributed in cash on establishment,20
and the shares must rank pari passu.21 Strict
requirements also apply to board membership
and persons responsible for investment
decisions,22 and all arrangements with entities
that are important for funds activities.
In effect, the form or regulation extends all
the way through the investment process,
i.e., custodian, brokers, etc., are also subject
to UNFE scrutiny which requires a three-
year business plan.23 Any entity may be a
shareholder in only one pension funds
company.24 This created some controversy
in the case of one bank, which was
simultaneously directly involved in one
company, while holding another company’s
shares in the form of global depository
receipts. The APF also envisages detailed
procedures in cases of funds acquisitions,
mergers and liquidation.25
The licensing process was closed at the end
of June 1999 and 21 funds were licensed,
including these created by foreign firms
such as Commercial Union, Nationale
Nederlanden, Norwich Union and Allianz,
and numerous domestic banks and insurance
companies. Four applications were rejected
for various reasons, but generally on the
grounds that in the UNFE’s opinion, the
shareholders could not ensure that the fund’s
operations would appropriately secure the
interest of the fund’s members.26
Investments
All pension companies and their respective
open pension funds are subject to strict
regulatory supervision. Investments of
pension fund assets are also highly regulated.
Restrictions on the investment of open
pension fund assets are to be as follows:27
■ 7.5% in recompensation vouchers
(a special instrument that will be created
to compensate certain state employees
and pensioners for a lack of prescribed
salary increases in previous years);
■ 20% in bank deposits and bank’s bonds
and other papers;
■ 40% in shares listed on the stock
exchange but no more than 10% on
parallel (second) market (for smaller firms)
and no more than 10% of all shares issued
by one entity (excluding preference or
other atypical types of shares);
■ 10% in shares traded on regulated
over-the-counter, allowed for public trading;
■ 10% in National Investment Funds
shares, in investment certificates issued
by funds and fully secured bonds issued
by other than municipalities entities;
■ 15% in mutual investment funds units,
other bonds publicly traded, particularly
issued by municipalities;
■ 5% in non-listed bonds and other papers,
■ 5% in other types of investment including
real estate and investment abroad.
These limits, coupled with minimum
investment returns requirements imposed
on funds, will significantly affect the
investment pattern of pension funds.
The APF defines the situation as a shortfall
in fund.28 This situation arises when the
rate of return for the last two years is lower
than the minimum required rate of return.
The minimum rate is equal to one half
of the weighted average of all funds’ rate
of return or is lower by 4 per cent from this
average, whichever of these values is lower.29
A shortfall must be covered primarily
from a fund’s reserve funds, which should be
created within the fund and amount to 1-3
per cent of assets, depending on their
volume.30 If this fund is not sufficient, the
universal pension fund company will have
to cover the shortfall from its own sources
within 14 days.31 If these funds are also
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OFE NationaleNederlanden
Winterhur OFE OFE Ego OFE BPH CUWBK
0
20
40
60
80
100%
Others
Shares
Bank deposits
Treasury and national bank papers
Source: OFE monthly reports
Portfolio of selected open pension funds (as of 30 June 1999)
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insufficient, the pension fund is to be
liquidated and its obligations are primarily
covered from the central guarantee fund.32
However, this fund is only limited to 0.1
per cent of all funds’ assets, so if the shortfall
is more severe it is to be backed directly by
the Treasury.33
It is expected that the relevant investment
regulations will heavily influence funds’
investment decisions. Particularly, it is
expected that a significant part of investment
will be directed towards debt instruments,
rather than equities. Fund managers will
not have a lot of freedom to undertake
riskier strategies while equity investments
are still limited, among other things, by
their low liquidity. According to preliminary
statements on investment strategies in
the start-up period, funds will be quite
reluctant to involve significant amounts
in equity instruments. Obviously, in the
longer term, it is expected there will be
a greater involvement in publicly traded
equities because of the experience of
developed economies.
The results of funds’ investment activity are
to be published in various forms, including
short monthly reports with a general split
of investment portfolio, half-yearly reports
with the list of all investments higher than
1 per cent of assets, and detailed yearly
reports with lists of all investments.34
A failure to comply with these information
obligations can expose the fund to heavy
penalties imposed by UNFE.35
Reform developments
The introduction of reform, however, has been
plagued by several delays. First, the date of
pension funds activities was postponed by
three months and their inauguration took place
on 1 April 1999. The initial months of their
activity were marked by a vigorous advertising
campaign, which was estimated to amount to
some 25 per cent of all advertising spending
in Poland during this period. By mid-July
some 5 million people had signed up to funds,
out of around 15 million eligible to join.
According to some early indications, the three
largest funds, i.e., Commercial Union BPH
CU WBK, Nationale Nederlanden and PZU
(the largest, state-owned insurance company)
captured some 70-75 per cent of the market,
followed by the funds of AIG, Norwich Union
and Zurich. The most effective sales
technique turned out to be through direct
contact and wide networks of salespeople,
while selling through banks, by telephone and
other forms generally failed. There have been
some examples of mis-selling and wrong
advertising practices and in a few cases
UNFE was reported to have warned and fined
some funds pursuant to its legislative powers.36
More importantly, the flow of funds to new
pension funds was significantly delayed due
to the problems associated with the creation
of the computer system for individual
accounts and complicated reporting
requirements for employers. During the first
three months, only some 8-10 per cent of
contributions due were actually transferred to
funds. The low amount of funds created
problems in fulfiling asset diversification
requirements, because such low sums did not
enable funds to purchase certain financial
instruments such as treasury bonds, of which
the cost for a single investment exceeded the
total amount of contributions received.
Therefore, the first half-year reports of
pension funds published at the end of June
1999 show that on average more than 50 per
cent of money was invested in bank deposits,
20 per cent in government paper, while the
unweighted average of equity holdings
amounted to 3.8 per cent. This situation
should change within the next few months
with larger inflow of contributions, but
involvement in equity instruments is
expected to remain low for some time.
In comparison with the previous PAYG
system, the new one is evidently more costly
to administrators. While administration of
benefits within ZUS amounted to less than
3 per cent of contributions, the average fee
charged on contribution by open pension
funds remains within a 7-10 per cent band,
although due to the impact of competition
some funds have already lowered them from
the original 15 per cent to between 8 per cent
and 11 per cent. Additional charges are
made on a monthly basis and depend on
the volume of accumulated assets (up to
0.05 per cent monthly), types of investment
made, etc. Additionally, overall system
start-up costs (such as establishing the
UNFE, the advertising campaign) were also
considerable. However, these costs are
expected to be covered by potential gains,
associated with investment growth, as well
as with overall increase in the volume of
savings in the economy.37
Pension reform was regarded as one of the key
issues in the process of Polish transformation
and was introduced simultaneously with
health sector and administrative reform.
The initial concept for the reform surfaced
17 See Art. 93.1 of the APF.
18 See Security Through Diversity, Office of
Government Plenipotentiary for Social Security
Reform, (Warsaw, 1997).
19 See Art. 31 of the APF.
20 See Art. 32.1 of the APF.
21 See Art. 30.3 of the APF.
22 See Art. 40-49 of the APF.
23 See Art. 54 of the APF.
24 See Art. 37 of the APF.
25 See Chapter 5, Art. 61-78 of the APF.
26 See Art. 57.4 of the APF.
27 See Art. 141-142 of the APF and Order of Council
of Ministry, dated 12 May 1998.
28 See Chapter 18, Art. 175-183 of the APF.
29 See Art.175.2 of the APF.
30 See Art.181-183 of the APF.
31 See Art.176.2 of the APF.
32 See Art.178 of the APF.
33 See Art.180 of the APF.
34 See Art.189 of the APF.
35 See Art.198 of the APF.
36 See Art. 197.2,3 of the APF.
37 See R. Holzmann, "Funded and Private Pensions
for Eastern European Countries in Transition",
Revista de Analisis Economico, 9, 1,
p.183-210, 1994.
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Information on selected open pension funds (as of 30 June 1999)
on the eve of transformation.38 The final
design of reform has taken place over the last
three years, stimulated by political will to
shake up the “old” system. However, after half
a year of implementing the new system, results
of public opinion surveys show that the new
system enjoys even lower public confidence
than the previous one. According to a GfK
Polonia39 survey, in mid-July 1999 only 5 per
cent of Poles strongly believed that the new
system would provide them with fair pensions
in the future (18 per cent were “quite
confident”), while 14 per cent did not trust
this system at all (16 per cent were “quite
unconfident”). This underlines the necessity
of disseminating information effectively that
is central to pension reform inauguration.
Conclusion
Polish pension funds will accumulate long-
term financial resources at a rapid pace, but
their role in corporate governance is likely
to depend on the development of the
domestic capital market and the impact of
regulations. Under the current framework,
they will be pressured to adopt a policy of
passive portfolios in an attempt to keep costs
down and cope with the regulations on the
minimum required rate of return. Moreover,
a 10 per cent limit on funds’ participation in
one entity will effectively reduce funds’
ability to influence significantly corporate
governance structures in invested firms.
Although the current lobbying efforts of funds
focus on reducing, or disapplying, the
required return mechanism and on increasing
the limit on investment abroad, the limit on
single investment in a company is likely to
be the next cause for lobbying. As a result, a
vacuum in corporate governance may emerge,
with limited corporate accountability to
shareholders, unless funds are given an
incentive, and shareholders are permitted to
become more actively involved in exercising
their rights in corporate affairs and
monitoring individual companies more
intensively.40 In view of the current regulatory
framework, their action in this area will
require great coordination and perhaps
cooperation with other players such as banks
and investment funds. Although it might be
expected that within the existing regulatory
framework, pension funds will not play a very
active role in corporate governance in the
short term, they will surely play an indirect
role by enriching and increasing the
availability of information about the firms,
which is crucial for financial market
development. The disclosure of information
is part of the process of developing corporate
governance because it helps to facilitate the
risk diversification policies of pension funds
and thus improves their performance.
Lastly, it is worth underlining that in relation
to pension systems, the EU has so far evaded
implementing reforms. Poland, however,
has taken these steps, at least in part, to
facilitate the process of joining the EU and
participation in monetary union. Budgetary
reasoning lies behind these reforms,
as social security spending is viewed as a
major factor contributing to budget deficits
and consequently high inflation. However,
it is increasingly recognised that the social,
economic and political issues which have
driven radical pension system reform in
Poland reflect not only Poland’s “transition”
experience but also the experience of the
wider and equally important global and
regional communities. Moreover, it is
possible to argue that insofar as certain
central and east European countries such
as Poland have moved much further with
pension system reforms than their EU
neighbours, their transition economies have
entered unfamiliar territory as potential
trendsetters, and their experience will also
be valuable for their future EU partners.
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38 See K. Chu, S. Gupta, "Social Protection
in Transition Countries: Emerging Issues",
Moct-Most, 6, p.107-123, 1996.
39 See Rzeczpospolita 21.07.1999
40 See D. Vittas, R. Michelitsch "Pension Funds in
Central Europe and Russia", Policy Research
Working Paper No. 1459, World Bank, 1995.
* Lukasz Konopielko
The Central and East European
Economic Research Center
ul. Batuty 3m.407
02-097 Warsaw
Poland
Tel: +48 22 822 7404
Fax: +48 22 822 7405
E-mail: [email protected]
Name of Total fund amountopen pension funds Owner (%) (million PLN)
OFE Nationale Nederlanden ING Continental Europa Holdings BV (80%)
Bank Slaski (20%) 4.013
Winterthur OFE Winterthur Life (70%)EBRD (30%) 0.343
OFE Ego BIG Bank Gdanski (55%)Eureko BV (45%) 0.157
OFE BPH CU WBK Commercial Union (80%)Wielkopolski Bank Kredytowy (10%)Bank Przemyslowo-Handlowy (10%) 3.714
Source: Asekuracja & Re, Rzeczpospolita various issues
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Aspects of corporategovernance in Russia
The rights and powers of the shareholders and boards of directors of Russian companies
have recently attracted significant attention as a result of the exercise by the boards of certain
companies of their powers to the detriment of shareholders. Foreign investors in particular have
found themselves unable to control or influence companies in which they have a significant
stake. There has also been a recent tendency for shareholders to exercise their rights to affect
the ability of the board to pursue its policies of choice. This article explains the principal rights
and powers of both the shareholders and the board of directors of Russian companies, both
in theory and in practice. It also examines the key issues which relate to the structure and
effectiveness of legal relations with the chief executive officer (CEO) in particular, and the
management of such companies in general.
Denis Uvarov, Assistant, and Iain Fenn, Partner, Linklaters & Alliance*
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This article deals only with the corporate
governance of joint-stock companies. This is
one of the two most common forms of Russian
company in which foreign investors are likely
to invest. The basic legal framework for the
corporate governance of such companies is
set out in the Joint Stock Companies Law of
1996. The legislation governing limited
liability companies is similar, although there
are specific differences which affect the
corporate governance of such companies.
Shareholders, the board andthe CEO
Until the Joint Stock Companies Law came
into effect in 1996, general meetings of the
shareholders of Russian companies could
determine any matter. The Joint Stock
Companies Law limits the issues which can
be determined by shareholders at general
meetings to a specific list of matters,1 with
all other matters being determined by the
board or the management. The intention
behind this legislation was to make the board
a forum of authoritative decision-makers
who could act in their personal capacities
and were independent of the shareholders
that sponsored their election. This intention
is reflected in a number of provisions
governing the election to, and the operation
of, the board (for example, directors may only
be appointed by general meeting not by
specific shareholders).
As a consequence of the enactment of the
Joint Stock Companies Law, while on paper
the general meeting is still technically “the
supreme management body of the company”,
the management focus of the company has
moved to the board of directors with the
general meeting being perceived as a means
of exercising shareholders’ rights rather than
making business decisions.
Each Russian company is required to have
a CEO who is appointed by the shareholders
or the board depending on the constitutional
document. CEOs of Russian companies
have extensive powers in relation to the
day-to-day running of the company. The role
of the CEO and the management board and
how the management structure can be modified
are described in more detail below. Examples
of the powers typically held by shareholders,
the board and the CEO are set out in the
table below.
Appointment of director
Appointment at the AGM
If investors wish to influence the business of
a Russian company, it is necessary for them
to obtain influence on the board of directors.
Directors in Russian companies may be
elected only by shareholders at the general
meeting and may not be directly appointed
by shareholders. Shareholders owning at least
2 per cent of a company’s issued share capital
may notify the company of candidates for
election to the board at the company’s annual
general meeting (AGM) following the end of
the previous financial year. The time-limits
for making this notification are strict and if
this notification is not received by the
company by 30 January,2 the shareholders’
candidate or candidates will not go on the list
of candidates for election to the board at the
AGM. Given the long delay between the
deadline for the notification of candidates
for election to the board and the AGMs of
Russian companies (which are usually held
in June), it is quite possible for the list of
candidates for election to the board to become
inappropriate or unhelpful for any number of
reasons, including shareholders having sold
their shares in the company. Even if this is
the case, there is no means of changing the
candidates for election at the AGM once the
time-limit for notification has passed without
a serious risk of the validity of the elections
being challenged by other shareholders.
Appointment other than at an AGM
The inability to appoint directors in a
company after the date on which the list of
candidates for election to the board at the
AGM has been finalised is clearly a problem
for any investor who buys a significant stake
in a company after such date has passed.
Power distribution in a typical Russian joint-stock company
Shareholders
• Reorganisation and winding-up
• Mergers and acquisitions
• Amendments to constitutional document
• Authorised but unissued capital
• Private offering of new shares
• Redemption of more than 10% ofoutstanding shares
• Transactions with a value above 50% of thebook asset value
• Related party transactions with a valueabove 2% of the book asset value
• Approval of annual dividend
Board
• Determination of the company’s strategy
• Public offering of new shares
• Appointment of the CEO and themanagement board and settingcompensations thereof
• Establishing subsidiaries and branches
• Participation in non-group organisations
• Payment of interim dividend
• Recommendation in respect of annualdividends
• Transactions with a value above 25% of thebook value of assets
• Related party transactions with a valuebelow 2% of the book value of assets
CEO
• Executing contracts and other documentson behalf of the company
• Issuing powers of attorney to act on behalfof the company
• Day-to-day running of the company
• Other matters not reserved forshareholders or the board
• Transactions with a value below 25% of thebook value of assets
• Approval of personnel schedule
• Orders to employees
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Such an investor has an interest in obtaining
board representation before the next AGM,
which may be more than a year away.
The position on the interim appointment of
directors is, however, far from clear-cut.
The Joint Stock Companies Law specifically
permits a general meeting of shareholders
to remove directors at any time provided that
the resolution is supported by a majority
of shareholders’ votes cast at that meeting.
Extraordinary general meetings (EGMs)
which are specifically convened for the early
re-election of the board are no longer unusual
in Russia. Unfortunately, although the Joint
Stock Companies Law deals with the early
removal of directors, it is silent on the
mechanism for the election of a new board
at an EGM. In particular, it is unclear who
is entitled to present candidates for election
to the new board. There is no procedure for
the board to ask shareholders for candidates
to be considered at an EGM and by the time
shareholders receive a notice of the EGM,
the draft resolutions, including the list of
candidates, should have already been
approved by the current board. The situation
is even more complex if the company’s board
is elected by cumulative voting (see below).
This is because the resolution for the early
termination of directors’ powers may be
passed only in respect of all members of the
board. That means that the whole new board
is at stake.
Various interpretations have been applied
to the legislation to deal with this lacuna.
For example, the provisions of the Joint Stock
Companies Law that entitle shareholders to
present candidates to the board for election
at an AGM are sometimes interpreted
to mean that shareholders are not entitled to
present candidates for election as directors at
an EGM. However, this interpretation would
mean that candidates to the new board could
be nominated only by the current board,
which would contradict the spirit if not the
letter of the Joint Stock Companies Law.
There is no simple answer which allows the
appointment of a new board nominated by
shareholders at an EGM without a risk of
either a removed director or a shareholder
bringing a claim disputing the legitimacy of
the new board. The best way of reducing the
risk of a challenge to the appointment of a
new board at an EGM is to give shareholders
notice of the proposed re-election of the
board and allow them a reasonable period of
time (one month, for example) to present
their candidates before the board finalises
the draft resolutions and actually convenes
the EGM. This solution is available only
where the current board is co-operative.
In practice, if the issue is not contentious,
people tend to agree the list of candidates
with other shareholders concerned informally.
The situation is much more complicated
if the board is reluctant to convene an
EGM for the re-election of the board and
the investor has to demand that such an
EGM be convened.3 In these circumstances,
although the board is under a statutory
obligation to comply with the demand, it is
under no obligation to give other shareholders
an opportunity to present candidates for
a new board. It may also be technically
difficult for them to do so, as the board
is obliged to convene such an EGM within
45 days from the date of the demand.
Voting at general meetings to maximiseboard representation
Russian law allows shareholders to elect the
board through cumulative voting. This means
that shareholders have their usual number
of votes multiplied by the number of seats on
the board and may distribute such multiplied
votes between candidates as they wish.
Cumulative voting is compulsory for companies
with more than 1,000 shareholders and
has also been adopted by many Russian
companies with fewer shareholders. While
cumulative voting should in theory ensure
that shareholders obtain a presence on the
board which reflects the size of their
shareholding, it does not always achieve
this result in practice. Representation on the
board may be affected by less than 100 per
cent of votes being cast as voting tactics
are usually predicated on all votes being cast.
In addition, many shareholders consolidate
their voting powers with other shareholders
and spread votes equally between agreed
candidates of both parties to achieve a greater
representation on the board.
Shareholders’ control andinfluence on incumbent board
Appointment of the CEO
The relationship between the shareholders
and the board is often determined by
which of them has the authority under the
constitutional document to appoint and
remove the CEO. The Joint Stock Companies
Law permits the CEO to be removed at any
moment without cause. Therefore, the body
with the power to make the appointment can
directly influence the day-to-day management
of the company. This is often more important
than the ability to make strategic decisions.
Generally, where the CEO is elected by
shareholders, the CEO’s position vis-à-vis
the board is more balanced, with the
CEO and managers of the company being
more independent of the board. However,
appointment by the shareholders does make
it difficult to change the CEO and the rest
of the managerial team. This can be a
particular problem for investors seeking to
consolidate a team of non-executive directors
(the members of the board) and executive
directors (the CEO and other managers)
or to concentrate the decision-making
processes of the company within the board.
1 Article 48 of the Joint Stock Companies Law
expressly restricts shareholders from determining
matters other than those included in the
exhaustive list of matters assigned to shareholders.
2 The company’s charter may provide for a later
date as the deadline for submitting nominations.
3 Shareholders who individually or collectively hold
at least 10 per cent of the company’s voting
shares are entitled to demand holding an EGM
with a particular agenda that may include
candidates proposed by such shareholder(s).
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The shareholders’ reservation of the power
to appoint the CEO can also lead to an
entrenched management, which can be
especially dangerous in times of crisis.
Currently, the right to appoint and remove the
CEO is reserved to the board in the majority
of big companies in Russia. Where the right
is reserved to the shareholders, a decision
on the appointment or removal of the CEO
generally requires a simple majority of votes
at the meeting unless the company’s charter
provides for a higher affirmative requirement.
Shareholders’ rights at general meetings
The board generally determines the agenda
for general meetings. Shareholders owning
2 per cent of the company’s share capital may
propose items for the agenda at the AGM.
This right is, however, limited to a maximum
of two items and may be exercised within
a strictly limited period of time. The board
may put as many items onto the agenda of an
AGM or an EGM as it considers appropriate.
In addition, the board may decide on the
order of items on the agenda. This can be
very important in certain circumstances, such
as when different groups of shareholders have
to vote on approval of each other’s interested
party transactions.
Shareholders owning at least 10 per cent
of the company’s shares may demand that
an EGM be held. In such circumstances,
the board may not change the wording of the
proposed resolutions but may add its own
resolutions and choose the order of the items
on the agenda. Although, the board is obliged
to convene such an EGM within 45 days from
the date of the demand, it can convene
another EGM preceding the one demanded
by the shareholders.4
Shareholders’ blocking rights
The most effective way in which those
shareholders who do not control the board
can influence or limit the actions of the board
is to block resolutions which the board must
refer to the general meeting.
Shareholders often use their power to block
resolutions proposed by the board in order to
protect their interests (for example, preventing
the board from effecting a new issue of shares
which would dilute the value of existing
shareholdings, or selling significant assets).
However, the effectiveness of such blocking
resolutions can be limited. This is best
illustrated by reference to an example.
One of the most frequently discussed
examples of malpractice in Russian companies
is the sale of the relevant company’s valuable
(sometimes core) assets to a related party
for doubtful (sometimes zero) consideration
(see below). Such sales have been effected
recently by the boards of companies in
circumstances where those boards have failed
to make the company a wholly-owned
subsidiary of a majority shareholder’s group,
or in order to retain control over the assets
in anticipation of the company’s insolvency.
In theory, shareholders can prevent such
transfers of assets. Most transactions with a
value exceeding 2 per cent of the company’s
book asset value with an interested party5
are subject to shareholders’ approval prior
to its becoming effective: the interested party
is prohibited from voting on the approval.
However, in practice, such transactions will
often not be put to shareholders for approval
as they have been structured so that the
person with whom the company is dealing is
allegedly outside the statutory definition of an
“interested party”. Although the requirement
covers affiliated persons of an interested
party by reference to the anti-monopoly
legislation, the definition of an “affiliated
person”,6 though relatively comprehensive,
is difficult to enforce (and in the case of
affiliated entities incorporated outside Russia,
almost impossible). In addition, affiliation is
sometimes effected through individuals so that
it is virtually untraceable and the requirement
becomes consequently unenforceable.
Blocking resolutions at general meetings are
also used with a view to putting pressure on
the board by shareholders. As there are many
technical or formalistic matters which require
approval by shareholders under the terms of
the Joint Stock Companies Law, there are
many opportunities for this pressure to be
applied. For example, shareholders can block
a new share issue by a company (even though
the issue is on fair terms and is proposed to
bring much-needed cash to the company) in
a situation where they do not have the funds
to subscribe for additional shares and would
prefer to see the company stagnate than see
their shareholdings being diluted. While such
shareholders may not have enough votes to
block a resolution on the share issue (which
requires 50 per cent of votes cast at the
meeting) they may have enough votes to vote
down formalistic approvals required for both
major7 and interested-party8 transactions
which carry higher affirmative requirements9
and which have to be passed before other
shareholders may buy additional shares.
Matters which require approval by a three-
quarters majority of votes cast at a general
meeting include amendments to the charter,
approvals of the amount of the authorised
capital and major transactions. Consequently,
significant shareholders in Russian companies
seek to obtain control of over 75 per cent
of voting shares by the company even if
they enjoy a strong presence on the board.
Conversely, minority shareholders will
generally try to consolidate their voting
powers up to a blocking vote of 25 per cent
of the voting stock plus one share.
Realising shareholder value
One of the most recent trends is the attempt
by shareholders, who have bought a company’s
shares at historically high prices, to force
the company to redeem their shares using
the statutory requirement for a mandatory
offer by the company to buy out its
shareholders. Such an opportunity arises
when the company undertakes certain actions
triggering the requirement to buy out
shareholders who voted against them or did
not vote. Such actions are as follows:
(i) a reorganisation of the company; (ii) the
entering by the company into a major
transaction which has a value exceeding
50 per cent of the book value of its assets;
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and (iii) the passing of an amendment to the
company’s charter that limits shareholders’
rights. It is not clear from the Joint Stock
Companies Law whether the buy-out
requirement is triggered by the actual
reorganisation or major transaction or by
the mere shareholders’ resolution to approve
that reorganisation or transaction. Some
provisions of the statute suggest that it is
the reorganisation or major transaction
becoming effective10 whereas other provisions,
such as those which describe the procedure
for the buy-out, envisage that shareholders
may exercise their put option within 45 days
from the date of the relevant resolution.11
So far as charter amendments are concerned,
shareholders attempting to force the company
to buy out their shares would interpret any
amendment, however technical, as prejudicing
their rights and try to persuade the court
accordingly.
Company accounts
As well as the difficulties that investors may
face in influencing the operation of Russian
companies, investors also need to be aware
of the difficulties that they may experience
in checking the adequacy of the financial
information about the companies in which
they invest.
The board is generally accountable to the
shareholders for the publication of annual
accounts at the AGM. In case of open
joint-stock companies,12 annual accounts
must be reported upon by an independent
auditor.13 As regards time between AGMs,
although the Civil Code entitles shareholders
owning 10 per cent of a company’s shares
to request a review of the accounts by an
independent auditor at any time, this may
be difficult to achieve in practice. Although
the Civil Code refers to the Joint Stock
Companies Law for the procedure for
conducting such reviews, the Joint Stock
Companies Law does not mention them.
In these circumstances, even if the board
were to allow such a review, it would be
under no obligation to respect the shareholders’
choice of auditor.
If shareholders have a concern about the
accounts of a company, a more realistic option
is to request that the company’s accounts be
reviewed by the internal Audit Commission.
This request can be made at any time by
shareholders owning at least 10 per cent of
shares. The Audit Commission is elected by
shareholders at each AGM to supervise the
company’s financial and business performance
and is independent of the board. The Audit
Commission is entitled by law to request from
the management any documentation relating
to the company’s financial standing. This
potentially powerful body has historically
been underutilised by the shareholders of
most Russian companies and interim reviews
of company accounts initiated by them have
been rare. The quality and impartiality of the
review will depend on whose representatives
are on the Audit Commission. Shareholders
are also entitled to propose candidates to the
Audit Commission as well as the board for
appointment at the AGM. One seat on the
Audit Commission may not necessarily solve
the problem of access to the company’s
accounts,14 but it does increase shareholders’
chances of obtaining a better picture of the
company’s financial position.
Directors’ duties and responsibilities
It is a feature of corporate governance in
a number of jurisdictions that directors are
under specific statutory or common law
duties to shareholders or the company. It is
also often an area explored by investors when
seeking relief for the actions of boards which
do not appear to be acting in the best
interests of the company. Under Joint Stock
Companies Law, directors are required to act
in the interests of the company and perform
their duties regarding the company reasonably
and in good faith.15 This requirement provides
only a vague and difficult to enforce basis for
the protection of minority shareholders and
this is reflected in the reluctance of minority
shareholders to seek protection for their
rights on these grounds. Neither the Russian
legislators nor the courts have so far
produced a clear notion of good faith that can
be applied to directors’ actions. Thus, in the
4 This is not possible if a company has more than
1,000 shareholders since such a company may
effectively convene an EGM only as early as on
the 46th day from the date of the principal decision.
5 The definition of an interested person in relation
to a joint-stock company is provided in Article 81
of the Joint Stock Companies Law. Examples of
interested-party transactions include transactions
entered by the company with the following persons:
shareholders owning 20 per cent or more of the
company’s voting shares, directors, other officers
and their affiliated parties. An interested-party
transaction requires the approval of a majority of
members of the board of directors who are not
“interested parties” in respect of the transaction.
Interested-party transactions with a value above
2 per cent of the company’s book asset value,
or entered in relation to the issue by the company
of new shares in an amount exceeding 2 per cent
of the company’s outstanding shares, are subject
to approval by a majority vote of shareholders
who are not the interested party in respect of
the transactions.
6 The Joint Stock Companies Law refers to the
definition of an “affiliated person” in the anti-
monopoly legislation. Such definition is provided in
Article 4 of the Law on Competition and Limitation
of Monopolistic Activity on Commodities Markets.
7 A major transaction is a transaction with a value
above 25 per cent of the company’s book asset
value or, in relation to the issue of new shares, an
issue in excess of 25 per cent of the outstanding
shares. The precise definition of a major transaction
is given in Article 78 of the Joint Stock Companies
Law. Transactions with a value of between 25 and
50 per cent of the company’s book value of assets
are subject to the unanimous approval of all
members of the board of directors. Transactions
with a value above 50 per cent of the company’s
book value of assets as well as such other major
transactions as have failed to receive the
unanimous vote of directors are subject to
approval by a three-quarters majority vote of
shareholders at a general meeting.
8 See note 5 above.
9 See note 5 above for approval of interested
party transactions and note 6 for approval of
major transactions.
10 Joint Stock Companies Law §75.
11 See id. §76.
12 An open joint-stock company is defined in the
Joint Stock Companies Law as one whose shares
may be alienated without consent from other
shareholders, and which may carry out public
offerings of its shares.
13 Closed joint-stock companies are not generally
under an obligation to have their accounts
reported upon by an independent auditor. Such a
company may become subject to the obligation in
certain circumstances including if it has issued
debt or its charter has been amended to require
specifically an independent audit of its accounts.
14 This largely depends on the procedure for the
operation of the Audit Commission that is
established by the general meeting of shareholders.
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absence of commonly applied tests, it
appears that a minority shareholder will have
a sustainable cause of action only where a
board’s action or decision has been either
negligent (see below) or plainly irrational.
It seems, however, that the problem of
directors’ actions lies deeper than just in
the simplicity of the statutory provision.
It has to be recognised that if directors are
appointed by a particular group or interest
they will owe allegiance to that group or
interest which will affect their actions.
The situation may take time to improve and
that improvement may depend on the holding
of assets by different groups becoming more
settled. A lot, of course, will depend on how
the relatively new concepts of the duty of
loyalty to the company and acting in good
faith are interpreted and developed by the
judges over the next few years as well as by
the readiness of those judges to go into
details of a particular situation and exercise
their discretion.
Under the Joint Stock Companies Law,
directors are liable to the company for any
damages inflicted on the company through
their negligent action or omission. The company
or a shareholder owning at least 1 per cent of
the company’s ordinary shares has the right to
bring an action against a director for the
damage caused by that director to the company.
Common abuses of board power
Dilution of interests in the share capital of the company
Much recent discussion has centred on the
dilution of minority shareholders in Russian
companies in circumstances where, for
example, major shareholders have been
seeking to make the company their wholly
owned subsidiary by forcing out those
minorities. Historically, this has been
achievable because shareholders in a
Russian company did not have pre-emption
rights in respect of shares placed through
a private offering. As a consequence,
shareholders were not consulted when the
board was planning to issue shares to a new
investor or to increase the shareholding
of only some of the existing shareholders.
As a consequence of the abuse of shareholder
rights, amendments were made to the
Standards of Share Emissions16 in April 1998,
which significantly limited the ability of the
board of a company to issue new shares by
a private offering at its discretion. A private
offering, and, rather unusually, a pro rata
offering to existing shareholders, now requires
shareholders’ approval. The recently published
Law on Protection of Rights and Lawful
Interests of Investors on the Securities Market
has also increased the limitations on private
placements of shares. The placement of new
shares through a private offering is now
generally subject to approval by a two-thirds
majority vote of shareholders and requires
the company to redeem the shares of those
shareholders who vote against the resolution
or did not vote.
The value of the shares to be issued may
also affect existing shareholders since it
determines, for example, the amount of funds
that shareholders need to put up in order
for their share not to be diluted. The Joint
Stock Companies Law requires new shares to
be issued at their market value as determined
by the directors. The Standards of Share
Emissions17 provides for three occasions
when an independent evaluator should be
engaged to determine the market value of
shares of an open joint-stock company to be
placed through a private offering. These are:
(i) when the offer is intended to be addressed
to a person who is not an existing shareholder;
(ii) when the shares are intended to be issued
other than to all existing shareholders; or
(iii) when the shares are intended to be issued
other than pro rata to existing shareholdings.
However, due to the board’s discretion in
relation to determination of the market value,
it is not strictly obliged to apply the valuation
supplied by the independent evaluator.
Consequently, deviation from a “subjective”
evaluator’s opinion towards a more “objective”
estimation can easily be justified in the
context of the business as a whole. In the
context of a rights issue, the board may, for
example, come up with a figure that is
advantageous to certain shareholders or
discourage other shareholders from taking
up their rights to additional shares.
Dilution of shareholders’ interests by payments in kind
Investors in some Russian companies have
also been subject to dilution in circumstances
where new shares have been issued for low
or even zero consideration to a majority
shareholder or related person. Although the
Joint Stock Companies Law provides that
shares should be paid up in full, the reality
is that while the obligation is formally
satisfied, the company may still receive zero
value in exchange for its shares. This is
commonly achieved by payment for shares
in kind (for example, with debt instruments
such as promissory notes, etc.). The market
value of such non-cash consideration must
be established by the board of directors.
There is a requirement for an independent
auditor to be contracted to evaluate a non-
cash consideration if the nominal value of
shares to be paid up with such non-cash
consideration exceeds a statutory limit (200
times the minimum statutory monthly wage).
However, it is often relatively easy to obtain
independent valuations that debt instruments
have a value of exactly the amount that needs
to be paid for the new shares. Needless
to say, a share issue that gives permission to
pay up shares in kind is often also a share
issue to dilute other shareholders’ interests.
The CEO and the management board
Peculiarities of the CEO’s office in a Russian company
It is difficult to underestimate the importance
of the CEO (usually called the President or
the General Director) in a Russian company.
Even where the CEO is appointed and hence
closely controlled by the board, the CEO has
significant power in terms of the day-to-day
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running of the company. In joint-venture
companies, a shareholder who exercises
influence on the CEO will be at a distinct
advantage to his joint-venture partner or
partners. No officers of a Russian company
(other than the CEO) can by their actions
bind the company vis-à-vis a third person
unless they have a written power of attorney
from the CEO. Although the signature of the
chief accountant is also required to enter
into any financial obligation of the company,
the chief accountant is, in practice, likely to
concur with the CEO.
The CEO is personally liable for breaches
of legislation by the company. The rationale
for this personal liability is that there must
be somebody who can be held personally
responsible for violations of various
administrative and other requirements.
In particular, legal entities other than people
may not be subject to criminal liability under
Russian law. Since all actions on behalf
of the company are deemed to be either
undertaken or otherwise authorised by the
company’s CEO, the CEO is deemed to be
a priori responsible for them all. The liability
of the CEO for certain breaches of legislation
can be very severe. Particular examples of
personal liability of the CEO include breaches
of currency control legislation, or those
imposed under insolvency law.
Apart from the CEO, a Russian company may
also have a management board, an executive
collegiate body undertaking day-to-day
management. Although in theory the manage-
ment board should act as a check on the
powers of the CEO, in reality the management
board usually comprises the CEO’s nominees
and is under his or her control. Therefore,
currently the CEO and the management
board are often perceived as a single body in
terms of the decision-making process.
The matters on which the CEO and the
management board have power to make
decisions are defined in the Joint Stock
Companies Law as all issues relating to the
day-to-day management of the company
except issues reserved to the board. This
comprises a wide range of issues, which
can be as important as those reserved to the
board. The board is generally not in a
position to control the actions of the CEO.
Therefore, although perfectly lawful, they
may drive the company into insolvency.
On the other hand, such concentration of
both important and technical responsibilities
with one individual often leads to ineffective
management. It stimulates the growth of various
consultative bodies under the CEO with poorly
defined roles and virtually no responsibility.
Although the management board was envisaged
as a forum for collective decision-making, it
rarely fulfils this role because members of
the management board often depend on the
CEO for their position and are discouraged to
be proactive on particular managerial issues.
Shareholders’ relationship with the CEO and the management board
Many investors, especially foreign investors,
are considering changing the structure of
corporate governance in their companies to
ensure more effective board or shareholder
control over the company’s management and
to improve the distribution and delegation
of authority within the company. There are
significant constraints to improving corporate
governance in Russian companies. Many
statutory provisions regulating corporate
governance are of a mandatory nature. While
logical at first glance, they are often construed
in such a manner that they impose unnecessary
restrictions or dictate certain features which
would not otherwise be desirable.
The most difficult problem facing an investor
who is looking at changing the way in which
a company is managed is how the board or
the shareholders can effectively control the
CEO and how to enable managers other than
the CEO to operate effectively without being
dependent on the CEO.
While the jurisdiction of the shareholders
of a company is limited by the Joint Stock
Companies Law, the jurisdiction of the board
is not. Therefore, the constitutional document
of a company may reserve to the board any
managerial issue which would otherwise
come within the mandate of the CEO and
the management board. Having taken a
matter from the CEO’s mandate, the board
can either deal with it for itself or delegate it
to a particular executive or committee who
will report to the board.
Even if the board has appointed a number
of executive officers who can effectively run
the company, there is still a requirement
for a CEO under the Joint Stock Companies
Law and the post may not be abolished.
However, there is nothing to stop the CEO
being merely another executive with his or
her own area of responsibility or purely
holding the position of “statutory” CEO.
Alternatively, it is equally possible to
combine the statutory role of CEO with the
ultimate responsibility for the company’s
operations and coordination of some of or all
other executives’ activity. Whichever option
is adopted, the peculiarity of the “statutory”
CEO’s office and his or her exposure to
liability for breaches of legislation by the
company cannot be removed.
As there is no legal requirement for a
management board, it can be abolished.
Alternatively, it may be adapted for the new
structure perhaps as an executive committee
or a CEO’s committee. There are, however,
certain issues that have to be considered if
the management board is to be so reorganised.
The management board, as it is envisaged in
the Joint Stock Companies Law, is a formal
body and that inevitably creates a degree of
bureaucracy. It also lacks comprehensiveness
and may fail to accommodate more specific
forms of executives’ forum. In general, it may
15 Joint Stock Companies Law §71.1.
16 Standards of the emission of shares under
establishment of joint-stock companies, additional
shares, bonds and for prospectuses thereof,
adopted by the Resolution of the Federal Securities
Commission of 17 September 1996, No. 19.
17 See id.
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be easier to create new forms of consultation
and collective decision-making than to adopt
this statutory body.
Enabling executives to act vis-à-vis third
parties without referring to the CEO is an
important feature of companies outside
Russia. It cannot be achieved as a matter of
Russian company law, but the Russian Civil
Code concept of agency can be utilised.
The CEO can issue executive officers with
formal powers of attorney enabling them to
act on behalf of the company within the
limits of their individual authority. This
arrangement could give a degree of instability
because as a matter of Russian law, a power
of attorney may be withdrawn at any moment
(even if it says otherwise) and because the
maximum period for which a power of
attorney may be issued is three years.
This is less of a problem if, as part of the
arrangement, the CEO is effectively obliged
to issue and maintain such powers of
attorney. If the CEO does not comply with
this requirement, he may be removed by the
board (provided that, under the constitutional
document, it is the board which appoints him).
There are of course limitations imposed by
the statutory framework which cannot be
adapted to a more investor-friendly style of
corporate governance. As well as the
statutory duties of the CEO, even if the
corporate governance of a Russian company
is restructured in the way described above,
there can be no guarantee that the CEO will
not take an action vis-à-vis a third party and
hence bind the company outside his reformed
authority, and there is little a company can
do to prevent such an action. Even if the
constitutional document of a company limits
the CEO’s powers, the actions of the CEO
vis-à-vis a third party taken in breach of such
limitations would still bind the company unless
it can prove that the third party “knew or
should have known” about the limitations.
* Denis Uvarov, Assistant
Iain Fenn, Partner
Linklaters & Alliance
One Silk Street
London EC2Y 8HQ
UK
Tel: +44 171 456 2000
Fax: +44 171 456 2222
E-mail: [email protected]
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developmentsdevelopments
Legal transition developments
Albania
L E G A L D E V E L O P M E N T S
Capital markets
A new regulation defining the functions and
activities of the supervising board of the
Tirana Stock Exchange (TSE) was approved
in April 1999. According to the regulation,
all the activities of the TSE would be run by
the Supervising Council of the Central Bank
of Albania (CBA), which would be presided
over by the governor of the CBA. Other
members would be the chief of the TSE,
a representative from the Ministry of Finance,
and stock exchange dealers selected by the
governor of the CBA.
Telecommunications
The Council of Ministers of Albania has
adopted a decision on 16 June 1999 by which
it has approved the Telecommunications Sector
Policy. This policy, which has been prepared
with EBRD assistance, outlines the short-term
and medium-term objectives of the government
in terms of telecommunications policy, and
announces the intention of the government
to liberalise all telecommunications services
by 2003 and its decision to privatise both
the incumbent operator, Albtelecom, and the
GSM operator, AMC, by the end of 1999.
Furthermore, the decision describes the
government’s policies towards the development
of telecommunications in the rural areas,
and its approach to licensing, interconnection,
numbering and frequency management.
Lastly, the policy also addresses the issue
of tariff regulation, including the actions the
government intends to take in order to rebalance
tariffs in a socially acceptable manner.
Armenia
L E G A L D E V E L O P M E N T S
The Law on the State Registration of Property
Rights was ratified on 30 April 1999. The
law regulates the right of state registration
of property and the operation of the system
implementing the state registration.
The National Assembly of Armenia adopted
the Law on Leasing Activity. The law
determines relations with distributors as
well as between different enterprises.
Entrepreneurs who use equipment leases
are given tax privileges for three years.
Armenia is moving towards accession to the
World Trade Organization (WTO), originally
scheduled for early 1998. Accession will
mean that Armenia’s laws should become
more in line with international standards and
will make the country more attractive for
foreign investments. The accession process
will require that Armenian competition laws
be changed as well as laws on monopolies,
businesses, industrial policy, accounting,
financial markets and financial institutions.
Azerbaijan
L E G A L D E V E L O P M E N T S
In April 1999, the Law on Limited Liability
Companies came into force after it was
published in the official press. This document
defines the juridical status of limited-liability
companies, the rights and obligations of their
founders, and also the general rules for their
establishment, operation, work, reorganisation
and liquidation.
Belarus
L E G A L D E V E L O P M E N T S
New Civil Code
The new Civil Code came into force on
1 July 1999. It is based on the CIS Model
civil code, which served as a model for the
Russian, Uzbek, Kazakh, Kyrgyz and several
other civil codes. It introduces and governs
a variety of corporate vehicles for businesses
and securities, regulates property and
property rights, contracts and intellectual
property rights, and contains basic rules
on international private law. The new Code
also regulates pledge and mortgage issues,
introduces the concept of insolvency, and
provides for the ranking of claims of creditors
upon liquidation of a legal entity.
Czech Republic
L E G A L D E V E L O P M E N T S
Capital markets
According to the new requirements of the
Prague Stock Exchange (PSE), effective as of
28 June 1999, companies with shares on the
PSE’s main and parallel markets will have
to disclose to the public certain information
about their subsidiaries, as well as on the
volume of outstanding loans, including the
names of the creditors. Significant changes
in management personnel control or on a
company’s board of directors must also be
reported. Companies now must also inform
the PSE in a timely fashion of any changes
in their financial situation that might affect
the price of their securities.
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Close-out netting legislation
At the request of the Czech National Bank,
the EBRD is undertaking a project to
assist the Czech Republic in developing
legislation to strengthen the enforceability
of close-out netting for over-the-counter
(OTC) derivatives contracts.
Hungary
L E G A L R E F O R M P R O J E C T S
Close-out netting legislation
At the request of the Ministry of Finance of
Hungary, the EBRD will initiate a project to
assist Hungary in developing legislation to
strengthen the enforceability of close-out
netting for OTC derivatives contracts. This
project will begin later this year.
Kazakhstan
L E G A L D E V E L O P M E N T S
Further Policy on the TengeExchange Rate
The Statement of the Government of the
Republic of Kazakhstan and the National
Bank of the Republic of Kazakhstan on
Further Policy on the Tenge Exchange Rate
was signed by the Prime Minister and the
Governor of the National Bank on 5 April 1999.
The Statement adopts the regime of a free-
floating exchange rate of the tenge as the
most appropriate regime under the current
condition of Kazakhstan’s open economy and
the unstable conditions in the international
financial and commodity markets.
Programme to attract foreign investment
The Kazakh Cabinet has developed a
programme for attracting direct foreign
investment in 1999–2000. The programme
includes principles of stability of the legal
framework for foreign investors and more
transparent legal procedures.
Tax Code amendments
Broad amendments to the Tax Code were
made in March 1999. The amendments
established new taxes and fees, increased
rates for some taxes and changed tax
administration in favour of taxpayers.
L E G A L R E F O R M P R O J E C T S
On 13 May 1999, the World Bank approved a
loan of US$ 16.5 million for a legal reform
project in Kazakhstan. The project will include
three components, namely legal drafting,
judicial strengthening and legal information.
Kyrgyzstan
L E G A L D E V E L O P M E N T S
Law on Investment Funds
The Law on Investment Funds was passed by
the parliament in June 1999. The law allows for
the establishment of mutual funds and defines
investment instruments in which an investment
fund may invest. The National Securities
Commission will issue licences to investment
funds and will oversee their activities.
Decree on development of securities
The President of Kyrgyzstan signed a decree
on measures to develop the securities market
on 13 May 1999. The decree aims at ensuring
transparency of the market in order to attract
greater investment in securities.
Moldova
L E G A L R E F O R M P R O J E C T S
Developing Moldova securities markets
At the request of the National Commission
for Securities of Moldova (MNCS), the
EBRD is developing a project to assist the
MNCS in developing and improving the
relevant legislation regarding the Moldovan
securities markets.
Poland
L E G A L D E V E L O P M E N T S
Capital markets
A new pension system came into force
on 1 January 1999, which substituted the
previous system. Under the new tri-pillar
system, the sources of financing for future
pensions are diversified.
Company law
A new draft of the law on companies was
published in early 1999. Although it has not
yet been introduced in the parliament, the
draft indicates the direction of developments
in Polish company law. One of the important
tasks of the new legislative efforts is to adapt
the Polish law to current market requirements
and to harmonise the national law with
EU standards.
L E G A L R E F O R M P R O J E C T S
Close-out netting legislation
The EBRD is planning a project to assist the
Polish authorities in developing legislation
to strengthen the enforceability of close-out
netting for OTC derivatives contracts.
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Regional
L E G A L R E F O R M P R O J E C T S
CIS model securities law
Since 1994, there has been a process of
harmonisation of commercial legislation
within the CIS member states, supported by
the Inter-Parliamentary Assembly of the CIS.
In July 1999, the EBRD approved a new
technical assistance project to develop the
CIS Model Securities Laws. The objective of
this project is to upgrade parts of the legal
environment for fostering economic reform in
the CIS member states, in order to facilitate
and promote a well-organised, modern,
efficient capital market, as well as to achieve
high standards in the protection of rights of
securities holders. This objective will be met
through the development of various model
laws dealing with all aspects of the securities
market, including transactions with securities,
their clearance and settlement, professional
participants in the capital market, regulator’s
authorities and licensing.
The project will be implemented by the Dutch
Centre for International Legal Cooperation
together with the Leiden University Institute
of East European Law and Russian Studies
and the CIS Centre for Private Law.
Romania
L E G A L D E V E L O P M E N T S
Legislation was passed in May to accelerate
economic reform in Romania (Law No.99 of
26 May 1999). It covers the following areas:
New pledge law
The new Law on Legal Treatment of Security
Interests in Personal Property was published
in the Official Gazette on 27 May 1999 and is
scheduled tocome into forceon26August1999.
It governs the creation, priority and enforcement
of security interests in personal property.
The law regulates security interests in all
types of personal property. Publicity of
security interests will be assured through the
creation of an electronic archive. A wide
range of debts can be secured under the new
provisions and, unlike the previous regime,
no distinction is made between the securing
of civil and commercial obligations.
Possessory pledges governed by the Civil
Code are still effective.
New privatisation law
The previous privatisation regime has been
amended. The new law aims to liberalise
the privatisation programme and accelerate
the process of moving state assets into the
private sector.
The law provides for a more accurate
manner of valuing and describing the assets
of companies undergoing privatisation.
The method of privatisation has also been
modified, introducing the possibility of
using privatisation agents to manage certain
privatisation transactions. The new law allows
for certain specified debts to be restructured
or forgiven for the purposes of encouraging
privatisation. It also expands the concept
of privatisation to allow the overall transfer of
state-owned assets into the private sector
and expressly provides for sales of properties
and assets of state-owned companies.
Russian Federation
L E G A L D E V E L O P M E N T S
Law on Specifics of Insolvency
The Russian Law on Specifics of Insolvency
(bankruptcy) of natural monopolies active
in the fuel and energy industries was signed
into law in June 1999. Under this law, certain
restrictions apply in relation to bankruptcy
of debtor enterprises that make products of
strategic importance for the Russian economy,
plants that constitute the core of the economy
of towns or state unitary enterprises.
Law on Amendments andAdditions to the Law on PropertyTax for Individuals
The Law on Amendments and Additions
to the Law on Property Tax for Individuals
came into force in July 1999. According
to this law, items subject to taxation are:
residential houses, flats, holiday homes,
garages and other premises and structures,
as well as aircraft, helicopters, ships, yachts
and other air and water transport vehicles.
Law on Restructuring of Credit Organisations
The Law on Restructuring of Credit
Organisations was enacted in July 1999.
The Law introduces the Agency for
Restructuring of Credit Organisations
(ARCO) as a state-owned corporation.
Under the law, a lending institution may be
reorganised if it holds not less than 1 per cent
of the total amount of personal deposits at
lending institutions in Russia as a whole,
or if its assets constitute not less than 1 per
cent of total assets at Russian lending
institutions. The law empowers ARCO to
take decisions on measures to financially
rejuvenate lending institutions, to increase
or decrease the charter capital of a lending
institution, and to make decisions on lending
institution reorganisations.
ARCO may also sell or convey the rights to
shares in lending institutions, grant loans,
make deposits, grant security, render other
financial assistance to lending institutions,
and liquidate lending institutions. The federal
authorities, the authorities of constituent
members of the RF, the local authorities and
the Central Bank of Russia “do not have the
right to interfere with the activities of ARCO.”
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Law on Foreign Investment in the Russian Federation
The Law on Foreign Investment in the
Russian Federation was enacted in July 1999.
The law specifies investment projects that are
eligible for special legislative regimes and
sets forth criteria for selecting investment
projects that can enjoy favourable treatment.
Specifically, projects with total foreign
investment at least Rb 1 billion, and
commercial organisations with a minimum
foreign share in the capital of no less than
Rb 100 million qualify for that treatment.
The list of projects has to be approved by
the government. The law also envisages
guarantees against any changes in Russian
legislation unfavourable for foreign investors.
Guarantees apply to foreign investors and
commercial organisations with foreign
investment if the foreign holding in the
capital exceeds 25 per cent. For industrial
and infrastructure projects in which
investments are recouped in a period
of more than seven years the government
will extend the term of “legislation stability”
guarantees. If a foreign investor fails to
meet obligations he has assumed he will
no longer be eligible for concessions set
out by the law.
Tax reform
In April 1999 there were some amendments
and additions made to the Federal Tax
Legislation, including to the Corporate Profits
Tax Law and VAT Tax Law. The amendments
include reduction of profit tax rate, tax
registration and profit tax payment requirements
for foreign companies, new tax exemptions,
and Value Added Tax issues. On 31 March
1999, the President signed (1) the Federal Law
on Amendments and Additions to the Law on
Tax on Profit of Enterprises and Organisations,
and (2) the Federal Law on Amendments and
Additions to Individual Legislative Acts of the
Russian Federation on Taxes. These laws came
into force on 1 April 1999. According to these
laws profit tax rate for most companies is
reduced from 35 to 30 per cent. The rate for
profit from intermediary activities and for
banks and insurance companies is reduced
from a maximum rate of 43 per cent to a
maximum rate of 38 per cent. The maximum
regional profit tax rate is reduced from 22 to
19 per cent for most companies, and from
30 to 27 per cent for profit from intermediary
activities and for banks and insurance
companies. The fixed federal profit rate is
reduced from 13 to 11 per cent.
Starting from 1 April 1999, foreign companies
are required to calculate their profit tax
liability on a quarterly basis and make
payments monthly. The options of calculating
profit tax on a monthly basis and making
payments once per month have not been
extended to foreign companies.
Amendments to the VAT (value added tax)
law that came into effect basically introduce
some technical changes.
L E G A L R E F O R M P R O J E C T S
Capital markets support
Under the auspices of the Joint EU/EBRD
Russia Task Force a technical assistance
project has been approved to provide for up
to six legislative workshops on proposed
capital market reform. It is very important
to build a consensus among participants
in the market and decision-makers in the
government and legislature.
This project aims to communicate the
initiative embodied in draft legislation
developed under an EBRD-sponsored project
and educating members of the parliament,
particularly deputies in the Duma, with
respect to: the need for this new legislation
based on a international practice; the effect
that this new legislation would have on the
securities market; and the legal consequences
of the current drafts and any different wording
that might be proposed.
Slovak Republic
L E G A L R E F O R M P R O J E C T S
New financial marketsupervisory authority
At the request of the Finance Ministry, the
EBRD is planning to undertake a project to
assist the Slovak Republic in establishing and
developing a new financial market supervisory
authority for the Slovak financial markets.
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Slovenia
L E G A L D E V E L O P M E N T S
Capital markets
A new securities law, which came into force
on 24 April 1999, obliges all companies
that sold their shares publicly to register
them at the central registering company
KDD in 60 days.
Secured transaction
The procedure for perfecting the security
interest created over properties pledged
now has to include a notarisation with the
notary public.
Turkmenistan
L E G A L D E V E L O P M E N T S
Law on Licensing of CertainTypes of Activities
The Law on Licensing of Certain Types
of Activities entered into force as of 16 June
1999. The law determines the legal basis
for licensing certain types of activities,
state bodies issuing licences, licence
requirements and the list of activities that
require licences.
Uzbekistan
L E G A L D E V E L O P M E N T S
Decree on privatisation
The Uzbek President signed a decree in May
1999 on privatisation which tightens control
over the implementation of privatisation.
The decree specifies objective and subjective
factors that guide privatisation activities
implemented in accordance with governmental
decisions. The State Property Committee
allocates revenues from privatisation
according to the scheme on a monthly basis.
Decree on procedure ofliquidating enterprises
The President signed a decree on measures
intended to simplify the procedure of liquidating
enterprises on 29 June 1999. The decree
authorises regional administrations to set up
permanent commissions within two weeks for
liquidating enterprises that have ceased their
activities and failed to form registered funds
by the legally prescribed dates.
L E G A L R E F O R M P R O J E C T S
In June 1999, the World Bank approved a
loan of US$ 25 million for a project aimed at
developing the banking sector of Uzbekistan.
The objective of the project is to strengthen
commercial banks’ corporate governance and
improve banking legislation. In addition, it
will strengthen the supervisory function of
the Central Bank.
Material in this section is provided by lawyers of
the EBRD’s Legal Transition Team:
Hsianmin Chen – Albania, Bulgaria, Czech Republic,
Hungary, Poland, Slovenia, financial market regulation.
Joachim Menze – Latvia, Moldova, Romania, Slovak
Republic, Ukraine, Secured Transactions Project.
Junko Shiokawa – Central Asia.
Meni Styliadou – Bosnia and Herzegovina, Croatia,
Estonia, FYR Macedonia, Lithuania,
telecommunications regulatory reform.
Alexei Zverev – Armenia, Azerbaijan, Belarus,
Georgia, Russian Federation.
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In the framework of its country programme
for Russia, the OECD Centre for Cooperation
with Non-Members (CCNM) organised a
high-level experts meeting on “Corporate
governance in Russia”, which took place in
Moscow from 31 May to 2 June 1999.
The meeting received broad support from
Russian institutions, and notably from the
Supreme Arbitrazh Court, the Federal
Securities Commission (FSC) and the National
Association of Securities Market Participants
(NAUFOR), a self-regulatory association.
It was co-sponsored by the World Bank and
the US Agency for International Development.
Participants included policy makers
and senior government officials, investors,
representatives of business and social partners,
governance experts and other international
organisations. The discussion focused on a
number of issues, including the ownership and
control environment, the legal framework for
corporate governance and its implementation,
and the relationship between shareholders
and enterprises in Russia.
The OECD has been involved in Russian
legal and institutional enterprise reform since
1992. The programme originally focused on
mass privatisation but has also emphasised
such issues as disclosure, insolvency and
corporate law reform. At an OECD meeting in
1998 on “The rule of law and the
development of a market economy in the
Russian Federation”, corporate governance
was identified as a key area where structural
reforms and the strengthening of institutions
needs to be pursued.
This recommendation also coincided with
growing interest in corporate governance
from OECD countries, sparked in particular
by the Asian financial crisis. As a result,
OECD ministers asked the Organization
last year to develop a set of corporate
governance principles that could be useful
to OECD members and non-member
countries alike. The endorsement of the
Corporate Governance Principles at the
OECD annual meeting of Ministers a few
days prior to the Moscow corporate
governance meeting reinforced the value
of using the principles to benchmark and
gauge progress in this area. Conference
participants agreed that there is great
scope for using the principles as a template
for reform.
The following is a summary of the main
themes and recommendations which arose
at the meeting in Moscow.
Main issues
The changing environment of ownershipand control in Russia
It is clear that Russia’s corporate governance
reform effort must inevitably take into
account the specific characteristics of the
country, the legal and cultural traditions, and
the underdeveloped market environment in
which its companies operate. However, as
capital markets are becoming global, it is
important that Russian corporations apply
some minimum standards of good corporate
governance in order to attract investment.
The ownership and control environment
has been significantly altered since
the 1998 financial crisis. As a result of
the weakened financial sector, banks as
owners cannot be expected to play an
important role in leading the corporate
restructuring effort, at least in the near
future. Although the state remains a
shareholder in a number of firms, its
financial weakness and inability to exercise
control has put in question its role both
as a shareholder and as a credible source
of financing. In contrast, foreign direct
investors and portfolio investors who were
largely absent as owners in the past could
play an important role in promoting good
corporate governance. In the short term,
enterprise managers could also play
a prominent role by taking responsibility
for encouraging corporate restructuring.
Their stance could be changing from general
suspicion regarding outside investment to
a more receptive attitude, recognising the
importance of investment for the survival
of enterprises.
Equitable treatment of shareholders and other stakeholders
Minority shareholders in Russia have
often faced a range of improper practices,
including asset stripping, improper transfer
pricing, share dilution, restricted access to
shareholder meetings and the barring of
outside investors from taking seats on the
board of directors. These practices are
harmful to the development of enterprises
and the attraction of outside investment.
Legal transitionevents
eventsevents
Legal transition events
OECD conference on corporate governance in RussiaFianna Jesover, Project Manager, Organization for Economic Co-operation and Development
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Self-dealing transactions are common
practice, in particular asset stripping.
Transfer pricing is widely used by holding
companies to transfer value from their
subsidiaries and outside investors to a
holding structure. Profits usually end up with
the management-controlled company.
Although the equity market is on a downturn,
new share issuance is on the rise. This is
often the result of efforts to dilute holdings of
minority investors. Companies frequently fail
to comply with the laws that regulate share
issuance, such as adequate pre-notification
for the exercise of pre-emptive rights.
Obstruction of share registration is also
prevalent. While independent certified
registrars must maintain most share registers,
some are still in the hands of the company’s
management. Therefore, minority
shareholders seeking to assert their rights
may be confronted with the company
manipulating the register.
In Russia, managers often undertake major
strategic moves without the consent of
shareholders. In order for shareholders to
influence the decision-making process in
a company, it is important that they can
exercise their voting rights at the Annual
General Meeting (AGM). In order to do so,
shareholders need to be furnished with
sufficient and timely information regarding
the date, location and agenda of the AGMs,
at which there should be an effective means
of shareholder participation and the
possibility of having their views represented
through the proxy mechanism. Enterprises
should be encouraged to broaden
participation by enlarging the use of modern
technology, including telephone and
electronic voting.
Another important instrument for ensuring
equitable treatment of shareholders is the
board of directors. This tool has not yet been
adequately exploited in most Russian
companies, where there is often blurred
responsibility between management and the
board. The board should be accountable to
all of the company’s shareholders, ensure the
fair treatment of other stakeholders and
corporate compliance with applicable laws
and regulations. Companies should be
encouraged to engage a sufficient number
of independent non-executive board
members where there is a potential for
conflict of interest or where independent
business judgement is advisable. Russian
companies that have introduced this measure
are seeing positive results in terms of access
to outside investment.
Much remains to be done in order to
improve the implementation of company law.
Shareholders should be encouraged to use
the legal remedies it offers to protect their
rights and to take grievances to the proper
regulatory authorities. The Arbitrazh Courts
should be assisted in building the
infrastructure and expertise necessary for
interpreting the law in an objective and
efficient way. Furthermore, the FSC should
be given the means to enforce the recently
adopted Law for the Protection of Investors.
Improving the integrity of markets
The Russian market suffers from a
considerable lack of transparency regarding
financial, ownership and corporate
governance arrangements, especially in
corporate groups. Experience in countries
with large and active equity markets shows
that disclosure has been a powerful tool both
for influencing the behaviour of companies
and for protecting investors. A strong
disclosure regime is a key feature of market-
based monitoring of companies and is central
to shareholders’ ability to exercise their
voting rights. Shareholders and potential
investors require access to regular, reliable
and comparable information in sufficient
detail for them to make informed decisions
about the acquisition, ownership and sale of
shares. Disclosure has often proven to be
more effective than detailed prescriptive
rules. Through the specialist press and other
reputable agents, it also helps improve public
understanding of the structure, activities and
policies of enterprises. Ultimately, enhanced
transparency and disclosure can be expected
to help the growth and deepening of financial
markets, encourage the efficient use of capital
and build confidence through predictability,
from which the whole society can benefit.
In Russia, the inadequacy of accounting
rules and standards has impeded the
development of an effective disclosure
regime. The necessary reforms of accounting
legislation have not yet been completed and
the accounting rules issued by the Ministry
of Finance are driven by tax considerations.
Companies with international investment
have the option to use international
accounting standards while at the same time
preparing accounts according to Russian
rules, but smaller companies cannot afford
such a dual accounting option.
In addition to financial disclosure, transparency
of ownership arrangements must be
enhanced. Too often, shareholders disguise
their ownership by buying shares through
one or more offshore companies, which
are not easily traceable to the owner.
This undermines the effectiveness of rules
on interested party transactions, insider
dealing, conflicts of interest and anti-
monopoly policies.
The FSC has a fundamental role in ensuring
effective transparency and disclosure as the
securities market regulator. In the past, its
power was limited by the lack of legal and
administrative enforcement tools. The recently
enacted law on the protection of investors’
rights is expected to give the FSC more
leverage in this regard, such as new fines
and sanctions for violations. The law affects
all market participants, including issuers,
intermediaries, investors and regulators.
This legislation is viewed as a welcome sign
that the Russian authorities are taking steps
to minimise foreign investor risk. Self-
regulatory associations, such as NAUFOR
and the Professional Association of Registrars,
Transfer-Agencies and Depositories
(PARTAD), are expected to play a prominent
role in developing business ethics in their
area, while efforts to set standards by
accounting/auditing professional bodies
will also be very important.
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Corporate governance practices inRussian enterprises
The discussion on the legal instruments
underpinning the corporate governance
environment in Russia revealed that, on
the whole, they are adequate. However, the
adoption of corporate governance rules in
itself is not enough to substantially improve
the performance of Russian enterprises.
There is a great need to enhance the
infrastructure in order to encourage effective
implementation and enforcement of these
rules. In this regard, it is important to sustain
the emergence of a set of intermediary
market institutions to help keep shareholders
informed and to assist them in exercising
their control rights. A lot can also be done
at the voluntary level, including the
continuing education of corporate managers
to bring about the behavioural change at
the enterprise level, without which reforms
may not become effective.
Most importantly, Russian enterprises
should realise that better corporate
governance serves their own self-interest.
To attract financing, enterprises have to
produce some value for outside investors,
ensure transparency of their financial
management and, most importantly,
relinquish some of their control over
corporate decision-making. In this regard,
a strong partnership between shareholders
and stakeholders (managers and employees)
in companies could be an important way
of achieving change.
Case studies on Norilsk Nickel and United
Energy Systems demonstrated the impetus for
corporate governance reform at the enterprise
level. Corporate decisions are increasingly
driven by the need to access financing
in international markets. The treatment of
shareholders and other stakeholders has
a direct impact on the capacity of companies
to survive and prosper in the global
marketplace. In this regard, the financial crisis
has been a catalyst. As liquidity started to dry
up, enterprises became confronted with the
realities of market forces and the importance
of building a strong corporate governance
framework. Managers are starting to appreciate
the value of establishing closer dialogue with
shareholders. Some large Russian companies
have created investor relations departments
and even introduced corporate governance
charters. However, much remains to be done
to improve the channels of communication
with minority owners.
The discussion on foreign investors’
expectations highlighted some of the
obstacles to foreign investment and
generated some recommendations on how
to meet these challenges. Weak corporate
governance has emerged as the most serious
impediment to foreign investment in Russia.
Not only does it drive investors away from
specific Russian corporations, it also creates
a negative image for the whole Russian
corporate sector and thus deprives even
transparent and honest enterprises from
attracting investment. Investors are
particularly concerned with disclosure and
transparency issues, such as the reluctance
of some Russian firms to provide adequate
financial, operating and strategic
information. Foreign investors are also
concerned about a lack of equal treatment
of foreign and domestic shareholders by
courts and local authorities. In this respect,
corruption is a major impediment.
A collective effort to introduce a code of
ethics, supported by professional associations,
major companies and investor groups, would
be important. This could complement efforts
at the regulatory and enforcement level as
well as help the emergence of a culture of
compliance and disclosure. As participants
pointed out, such an effort could be based
on the OECD’s principles.
Role of the state as a shareholder
The Ministry of State Property remains a
majority shareholder in over 12,000 state-
owned-enterprises and a minority shareholder
in over 3,800 companies with no coherent set
of goals to exercise its ownership rights.
Assets are managed mostly via state boards
composed of 2,000 members of ministries
and agencies. Coordination between them
is poor and their powers are ill-defined.
Using privatisation as a tool for improving
corporate governance and creating better
capital markets has met with success in many
countries, including emerging and transition
economies. In Russia, privatisation has not
yielded entirely satisfactory results due to
the lack of a transparent and competitive
process. The success of future privatisation
efforts will depend on their openness and
competitiveness. Moreover, in the wake of the
financial crisis, privatisation may be used as
a tool to introduce foreign investment and
broaden capital markets.
Another concern is the current trend to
re-politicise property management by shifting
responsibility over ownership rights from the
Ministry of State Property to individual
ministries. This is likely to further blur the
lines of accountability. It is important to
distinguish between the role of the state as a
regulator and a shareholder. As regulator, the
state should address public interest concerns
in natural monopolies and infrastructure
sectors. Specific institutions should fulfil
these functions. These should be different
from state agencies holding and managing
shares of state-owned enterprises.
Conclusion
While external developments have
contributed to Russia’s economic hardship,
it is now widely recognised that structural
policy shortcomings in the investment
process, including the lack of effective
corporate governance mechanisms, have
been an important factor. It is true that many
foreign investors exhibited little prudence
in providing financing regardless of the lack
of transparency of corporate governance
arrangements. However, there is a growing
awareness that one of the vital conditions
for investors to return to Russian companies
is an improvement in corporate governance
mechanisms. Enterprises that have introduced
transparency, accountability and
independence at the board level have seen
their wealth preserved and investors still
willing to support them despite the overall
country/market risk. Thorough restructuring
of the financial sector in the wake of the crisis
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might also represent an opportunity for a more
transparent corporate governance structure
and the establishment of an arm’s-length
relationship between banks and corporations.
A number of recent corporate governance
abuses have generated intense discussion
about the future of Russian enterprises in the
coming years. Investors have often seen their
shares diluted by insiders and major
shareholders. Enterprises have been stripped
of their assets by various means of transfer
pricing and other related transactions.
The interests of creditors have not been
adequately protected. Poor corporate
governance practices have hampered the
mobilisation of outside capital and cultivated
conflicts of interest. These weaknesses have
been compounded by serious deficiencies in
the tax and accounting systems as well as
institutional structures.
Russia has achieved substantial progress in
enacting essential economic legislation
during a relatively short time-span. However,
important work remains to be done to allow
better corporate governance to emerge.
This includes:
■ strongly encouraging competitive processes
in the market for corporate control,
including reducing barriers to entry,
promoting de-monopolisation and
facilitating efficient market exit;
■ implementing and enforcing existing laws
and regulations by strengthening the
institutional capacity of the judiciary and
regulatory authorities (mainly the Supreme
Arbitrazh Court and the FSC) and
deepening the understanding of the issues
involved; and
■ improving the business culture by raising
awareness of these issues in Russian
enterprises and building private
institutions that will foster the development
of business rules and ethics.
Increasing the responsibility and role of
enterprises could encourage the development
of an accountable and transparent corporate
sector, an important prerequisite for a more
open economy and society, with integrity and
accountability at all levels.
What’s next
The Moscow conference succeeded in
identifying the future direction of the policy
discussion on corporate governance in Russia,
using the OECD’s principles as the main tool.
One of the most important results of this
meeting is the establishment of a permanent
dialogue structure, “The Corporate Governance
Round Table for Russia”. The Round Table
will be co-sponsored by the OECD and the
World Bank and will be set up in co-operation
with the main Russian institutions, both
public and private, that actively backed the
June meeting. This would help raise and
maintain momentum for corporate governance
reforms and ensure high-quality advice for
the public and private sector decision-makers
involved in this effort.
The Round Table’s primary functions will be to:
■ promote good corporate governance by
using as a starting reference point the
OECD’s principles and to further develop
them to address Russian concerns;
■ generate dialogue on these issues and
disseminate international experience and
best practice by bringing together on a
regular basis public and private sector
experts from OECD countries and,
possibly, other transition economies with
their Russian counterparts;
■ identify areas for further work at policy level
and to help identify technical assistance
needs in the private and public sectors; and
■ make recommendations for policy
implementation and to regularly review
progress and take stock of corporate
governance developments.
The first meeting of the Round Table
is planned for early 2000. In addition to
its regular meetings, the Round Table may
organise smaller meetings of experts
on selected subjects. It will also encourage
frequent dialogue on improving corporate
governance in Russia by setting up
an Internet website and an electronic
discussion group.
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* Fianna Jesover
Project Manager
Directorate for Financial
Fiscal and Enterprise Affairs
Organization for Economic Co-operation
and Development
2 rue Andre Pascal
75016 Paris
France
Tel: +33 1 45 24 98 13
Fax: +33 1 45 24 94 32
E-mail: [email protected]
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Seminar on telecommunicationsregulation and privatisation in Kiev
In cooperation with the European Commission,
on 19 May 1999, the EBRD organised a
seminar in Ukraine on telecommunications
regulation and privatisation. The main
objective of the seminar was to provide
members of the Ukrainian Parliament and
senior civil servants with information on some
of the recent privatisations in central and
eastern Europe as well as the most recent
trends in telecommunications regulation.
EBRD representatives, Lindsay Forbes,
Marykay Fuller, Meni Styliadou, Mark Dutz,
Ken Lonnen and Franck Noiret, described to
the Ukrainian participants their experience
regarding telecommunications privatisation
in Romania and Moldova as well as the result
of an analysis carried out by the EBRD’s
Office of the Chief Economist on the impact
of privatisations on the performance of
the company, the quality of service, etc.
A presentation on the Hungarian privatisation
was made by a director from the Hungarian
Ministry for Telecommunications. Presentations
were also made on the difficult issue of
tariff rebalancing and on the recent trends
in telecommunications regulation in the
European Union.
Seminar on financial marketlaw reform in Luxembourg
On 25 March 1999, under the sponsorship of
the Government of Luxembourg, the EBRD
participated in a seminar on the reform of
banking and capital markets laws in transition
countries. The seminar, held in Luxembourg,
was organised by George Heinen, the Bank’s
Alternate Director for Belgium, Luxembourg
and Slovenia, in connection with the
publication of the spring 1999 issue of Law
in transition, which focused on financial
markets law reform and was sponsored by
the Luxembourg Government. Participants
in the seminar included Minister of Justice,
Minister of the Budget and other officials
from the Government, lawyers, certified
public accountants and other professionals.
Speakers at the seminar from the EBRD
included George Heinen, Gerard Sanders,
Hsianmin Chen and Jonathan Harfield.
Gerard Sanders, Assistant General Counsel,
gave a presentation on the legal transition
programme of the EBRD. Hsianmin Chen,
Counsel, focused on a specific legal technical
assistance project, i.e., close-out netting
legislation, to indicate how the EBRD delivers
legal technical assistance to its countries of
operations under the Bank’s Legal Transition
Programme. The presentation made by
Jonathan Harfield, Senior Banker and
Country Team Director for the Czech Republic
and the Slovak Republic, concerned money
laundering in central and eastern Europe.
Meeting of IOSCO’s Committeeon the Implementation of“Objectives and Principles ofSecurities Regulations” in Lisbon
On 22 May 1999, the Committee on the
Implementation of “Objectives and Principles
of Securities Regulations” advocated by the
International Organization of Securities
Commissions (IOSCO) held a meeting in
Lisbon. This meeting was organised to, among
others, explore how IOSCO could co-operate
with other international organisations in
implementing IOSCO's “Objectives and
Principles of Securities Regulations”.
Hsianmin Chen, Counsel of the EBRD's
Legal Transition Team, made a presentation
to report the results of an EBRD survey on
capital markets laws in the countries of
central of eastern Europe and the CIS. The
occasion was a further opportunity to
enhance coordination among providers of
legal assistance for the development of
securities markets.
International Bar Associationconference on “The EuropeanUnion Goes East – Impact ofthe Acquis on Investment inCentral and Eastern Europe” in Prague
The conference took place in Prague on
17-19 May 1999 and was hosted by the
IBA’s East European Forum and the Czech
Bar Association. Attendees included
representatives of the governments of east
European states and international financial
institutions as well as private lawyers.
The conference agenda focused primarily
on the Czech Republic, Hungary and Poland,
with some discussion on developments in
the Slovak Republic. Discussions centred
on the latest developments in competition,
procurement, company and capital markets
law and regulation, with an emphasis on
changes in law as a result of countries
adopting the acquis communautaire.
David Bernstein, EBRD Chief Counsel,
presented the results of the EBRD’s legal
surveys on financial market regulation and
provided a description of the Bank’s efforts in
assisting with the development of well-
regulated capital markets. A consistent theme
among the presentations at the conference
was the need for these countries to continue to
update their commercial legislation to bring
it in line with the acquis while focusing on
and financing the development of institutions
that can effectively implement these new
laws. Hungary and Poland were singled out
as examples of how to achieve this.
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Global Corporate GovernanceForum planning session inWashington, DC
On 29 July 1999, the World Bank and the
OECD hosted a planning session for the
Global Corporate Governance Forum that
will be initiated at the World Bank/IMF
Annual Meetings in Washington in late
September of 1999. The Global Corporate
Governance Forum is a “joint-venture”
between the World Bank and the OECD
designed to help promote the development
of sound corporate governance practices
in developing and transition countries, using
the OECD Principles of Corporate Governance
as a starting point. The Forum secretariat
is presently funded by the World Bank,
where it will also be based.
The Forum is directly supported by a Private
Sector Advisory Group (PSAG) chaired by
Ira Millstein, Senior Partner, Weil, Gotschal
& Manges LLP. Its membership includes
Mark Mobius, President, Templeton Emerging
Markets Fund, Inc., Michel Albert, former
Chairman, Assurances General de France,
Yoh Kurosawa, Chairman, The Industrial
Bank of Japan, and other leading business
representatives from around the world.
The PSAG will support the Forum by
attempting to convince their private sector
colleagues in developing and transition
countries of the need for corporate
governance reform.
During the planning session representatives
of international financial institutions,
organisations and individuals active
in promoting sound corporate governance
and business representatives discussed
ways in which the Forum could support
existing corporate governance initiatives.
There was a consensus that the Forum
could serve as a clearing house and resource
base for ongoing efforts. In particular,
the role of the PSAG was seen as vital for
identifying reform champions and building
up momentum for reform in developing and
transition countries. The OECD announced
that it would initiate a series of corporate
governance round tables in specific
countries, along the lines of its Russian
round table, in an effort to start a reform
dialogue among government, the private
sector and foreign investors.
79
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79
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World Bank insolvency symposium in Washington, DC
On 13-14 September 1999, the World Bank hosted a symposium of insolvency experts as a
first step in its efforts to identify principles and guidelines for sound insolvency systems and
for strengthening related debtor-creditor rights. This insolvency initiative is part of the wider
G-7, G-22 and IFI effort to improve the future stability of the international financial system.
The World Bank has formed an Advisory Panel comprising representatives of international
organisations, including the EBRD, to guide the effort and to assist a Task Force comprising
leading insolvency experts from around the world. The Task Force is charged with taking the
results of the symposium, contained in ten working papers, and developing draft principles
and guidelines. The working papers and the draft principles and guidelines will be available
for review and comment on the World Bank’s legal insolvency database under the site heading
for “Best Practices” later this year.
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This two-volume glossary is designed to aid mutual understanding
between the Russian-speaking and international business communities.
Compiled by the European Bank for Reconstruction and Development, it covers the
latest banking, economic and legal terminology.
Available in both Russian-English and English-Russian at £50 each or £90 for the set.
EBRDGlossary of
Project Finance
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3849
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4155 LiT A99 (E) - pdf 26/10/99 2:20 pm Page 80
The European Bank for Reconstruction and Development (EBRD) is an international institution
whose members comprise 58 countries, the European Community and the European Investment Bank.
The EBRD operates in the countries of central and eastern Europe and the Commonwealth
of Independent States committed to multiparty democracy, pluralism, and market economies.
The EBRD’s countries of operations are Albania, Armenia, Azerbaijan, Belarus, Bosnia and
Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, FYR Macedonia, Georgia, Hungary,
Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Poland, Romania, Russian Federation,
Slovak Republic, Slovenia, Tajikistan, Turkmenistan, Ukraine and Uzbekistan.
The EBRD works through the Legal Transition Programme, which is administered by Office of the
General Counsel, to improve the legal environment of the countries in which the EBRD operates. The
purpose of the Legal Transition Programme is to foster interest in, and help to define, legal reform
throughout the region. The EBRD supports this goal by providing or mobilising technical assistance for
specific legal assistance projects which are requested or supported by governments of the
region. Legal reform activities focus on the development of the legal rules, institutions and culture on
which a vibrant market-oriented economy depends.
Law in transition is a publication of the Office of the General Counsel of the EBRD. It is published several times eachyear and is available in English and Russian. The editors welcome ideas, contributions and letters, but assume no
responsibility regarding them. Submissions should be sent to David Bernstein, Office of the General Counsel, EBRD,One Exchange Square, London EC2A 2JN, United Kingdom; or [email protected]
The contents of Law in transition are copyrighted and reflect the opinions of the individual authors and do notnecessarily reflect the views of the authors’ employers, law firms, the editors, the EBRD’s Office of the General
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